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Short Squeeze, Liquidity, Margin Debt & Deflation

Tyler Durden's picture




 

Submitted by Raul Ilargi Meijer via The Automatic Earth blog,

Some things you CAN see coming, in life and certainly in finance. Quite a few things, actually. Once you understand we’re on a long term downward path, also both in life and in finance, and you’re not exclusively looking at short term gains, it all sort of falls into place. The only remaining issue then is that so many of you DO look at short term gains only. Thing is, there’s no way out of this thing but down, way down.

Yeah, stock markets went up quite a bit last week. Did that surprise you? If so, maybe you’re not in the right kind of game. You might be better off in Vegas. Better odds and all that. From where we’re sitting, amongst the entire crowd of its peers, this was a major flashing red alarm late last week, from Investment Research Dynamics:

September Liquidity Crisis Forced Fed Into Massive Reverse Repo Operation

Something occurred in the banking system in September that required a massive reverse repo operation in order to force the largest ever Treasury collateral injection into the repo market. Ordinarily the Fed might engage in routine reverse repos as a means of managing the Fed funds rate.

 

However, as you can see from the graph below, there have been sudden spikes up in the amount of reverse repos that tend to correspond the some kind of crisis – the obvious one being the de facto collapse of the financial system in 2008. You can also see from this graph that the size of the “spike” occurrences in reverse repo operations has significantly increased since 2014 relative to the spike up in 2008. In fact, the latest two-week spike is by far the largest reverse repo operation on record.

Besides using repos to manage term banking reserves in order to target the Fed funds rate, reverse repos put Treasury collateral on to bank balance sheets. We know that in 2008 there was a derivatives counter-party default melt-down. This required the Fed to “inject” Treasury collateral into the banking system which could be used as margin collateral by banks or hedge funds/financial firms holding losing derivatives positions OR to “patch up” counter-party defaults (see AIG/Goldman).

 

What’s eerie about the pattern in the graph above is that since 2014, the “spike” occurrences have occurred more frequently and are much larger in size than the one in 2008. This would suggest that whatever is imploding behind the scenes is far worse than what occurred in 2008. What’s even more interesting is that the spike-up in reverse repos occurred at the same time – September 16 – that the stock market embarked on an 8-day cliff dive, with the S&P 500 falling 6% in that time period. You’ll note that this is around the same time that a crash in Glencore stock and bonds began. It has been suggested by analysts that a default on Glencore credit derivatives either by Glencore or by financial entities using derivatives to bet against that event would be analogous to the “Lehman moment” that triggered the 2008 collapse.

 

The blame on the general stock market plunge was cast on the Fed’s inability to raise interest rates. However that seems to be nothing more than a clever cover story for something much more catastrophic which began to develop out of sight in the general liquidity functions of the global banking system. Without a doubt, the graphs above are telling us that something “broke” in the banking system which necessitated the biggest injection of Treasury collateral in history into the global banking system by the Fed.

That should scare even the crocodile hunter, I venture, but he’s dead, and you’re not. So move one to the next sign that you’re in way over your head. How about Tyler Durden quoting Bank of America. Turns out, last week’s gains were down to one thing, and one only: short covering. In fact, the second biggest short squeeze in history. So much short covering that stock prices went up. And that’s why they did.

Stocks Soar To Best Week In A Year On “Mother Of All Short Squeezes”

With China shut and The Fed going full dovish panic-mode over growth fears, world markets went crazy…
• S&P up 7 of last 8 days +3.2% – best week since Oct 2014
• Russell 2000 +4.5% – best week since Oct 2014
• Nasdaq up 7 of last 8 (since Death Cross) closed above 50DMA
• Trannies up 8 of last 9 +4.9% – best week since Oct 2014
• Dow up 8 of last 9 +3.5% – best week since Feb 2015
• "Most Shorted" +4.7% – biggest squeeze in 8 months
• Biotechs -2.3%
• Financials +2.2% – best week in 3 months
• Asian Dollar Index +1.4% (worst week USD vs Asian FX since Oct 2011)
• Dollar Index -1.2% (worst week for USD vs Majors in 2 months)
• AUD +4% – best week since Dec 2011
• 2Y TSY Yields +6.5bps – biggest rise in 7 weeks
• 5Y TSY Yields +11bps – biggest rise in 4 months
• WTI Crude +8.9% – 2nd best week since Feb 2011
• OJ +4.8% – best day since March
• Silver +3.8% – best week since May

LOLume!!

 

The last 8 days have seen a massive short-squeeze… 2nd biggest in history

 

The last 2 times stocks were short-squeezed this much, did not end well…

 

And the following stunning chart shows the percent of S&P 500 names above their 50-day moving-average has soared from 4% to 60% in a few weeks…

h/t @ReformedBroker

 

Got that? The biggest injection of Treasury collateral in history combined with the 2nd biggest short squeeze in history. Still want to buy stocks? Think there’ll be an actual recovery?

And then there’s this mass selling of Treasuries by emerging markets, as per the following Economist graph.

How many trillions are we down so far? And you still want to buy ‘assets’? You sure you can spell the word please? Josh Brown at the Reformed Broker thinks maybe that’s not the smartest move around:

QE Causes Deflation, Not Inflation

In America, Japan and the Eurozone velocity has continued to decline since the financial crisis in 2008. Thus, US, Japan and Eurozone money velocity, measured as the nominal GDP to M2 ratio, has declined from 1.94x, 0.7x and 1.29x respectively in 1Q98 to 1.5x, 0.55x and 1.05x in 2Q15.

 

Indeed, US money velocity is now at a six-decade low. This is why those who have predicted a surge in inflation in recent years caused by the Fed printing money have so far been proven wrong. For inflation, as defined by conventional economists like Bernanke in the narrow sense of consumer prices and the like, will not pick up unless the turnover of money increases. This is the problem with the narrow form of mechanical monetarism associated with the likes of American economist Milton Friedman.

[..] QE is deflationary because it shrinks net interest margins for banks via depressing treasury bond yields. It also enriches the already wealthy via asset price inflation but they do not raise their consumption in response, because how much more shit can they possibly buy? Finally, it leads to a preference of share buybacks vs investment spending because the payback from financial engineering is so much easier and more immediate.

Now, we’re not sure that QE ’causes’ deflation, or let’s put it this way: perhaps QE doesn’t cause the deflation we see, but it certainly reinforces it. ‘Our’ deflation originates in our debt. And there’s more than plenty of that to go around.

More is still being added on a daily basis. Though we’re approaching the limits of that. Which is a good thing on the one hand, but a bad one on the other: we’re all going to feel like heroine junkies going cold turkey. Not a pleasant feeling. But still healthier in the long run.

That US money velocity is at its lowest pace in 60(!) years -do let that one sink in- is a huge component of what deflation really is: not rising or falling prices, but the interaction of falling/rising money supply vs falling/rising money velocity.

And in that sense, isn’t it interesting to note that “US money velocity is now at a six-decade low.”?! And that, accordingly, no matter how much money is injected into the economy, if it is not being spent, deflation is inevitable?!

Why is it not being spent? Because America, wherever you look, and at whatever level, the country is drowning in debt. And so is the rest of the planet. If a large enough part of your ‘gains’ goes toward paying of what you’ve already spent in the past, you’re just a hamster on a wheel. Well, hamsters rule the planet.

And, now that we’re talking about it, deflation is inevitable anyway in the aftermath of the by far biggest credit mountain in the history of not just mankind, but of the planet, if not the universe.

It may be hard to let sink in if you and/or your pension fund own large(-ish) portfolios of stocks and bonds, or if you make a living trading the stuff, but come on, how long do you think you can keep the charade going? or should that be: ‘could keep it going’?

To add insult to injury, Bloomberg tells us that margin dent is falling fast in ‘da markets’. Ergo: smarter money is paying its money down, before too much of it vanishes into the great beyond. Watch that graph and imagine it going all the way back down to 2012, and then think about where your ‘assets’ will be.

Margin Debt in Freefall Is Another Reason to Worry About S&P 500

Most people get concerned about margin debt when it’s shooting up. To Doug Ramsey, the problem now is that it’s falling too fast. The CIO of Leuthold Weeden whose pessimistic predictions came true in August’s selloff, says the tally of New York Stock Exchange brokerage loans flashed a bearish sign when it slid more than 6% in July and August. The retreat took margin debt below a seven-month moving average that suggests demand for stocks is dropping at a rate that should give investors pause. For years, bull market skeptics have warned that surging equity credit portended disaster for U.S. shares, pointing to a threefold runup between the market low in March 2009 and the middle of this year. Ramsey, who says that surge was never strong enough to form the basis of a bear case, is now worried about how fast it’s unwinding.

 

“Margin debt contracting is a sign of loss of investor confidence and it’s confirmation of a lot of other evidence we have that we’ve entered a cyclical bear market,” Ramsey said in a phone interview. “We got a lot of traditional warning signs leading up to the high in terms of market action, and deteriorating breadth and margin debt is important to the supply-demand analysis.” Margin debt, compiled monthly by the NYSE, represents credit extended by brokerages for clients to buy stock. It hews closely to benchmark indexes such as the S&P 500, primarily because equity is used to back the loans and as its value rises, so does the capacity to lend.

Of course, the entire global economy has been hanging together with strands of duct tape for decades now, but hey, it looks good as long as you don’t take a peek behind the facade, right? But you know, it all comes together in that money velocity graph earlier.

People have massively toned down their spending, some because they’ve grown wary of what’s going on, but most because they either have nothing left to spend or they are too deep in debt to have anything left after they pay their money down.

And there’s no cure for that. Not even a people’s QE will do it, no matter what shape it would come in. The entire world economy would need to restructure its various debt levels.

Problem with that is, A) we’ve already committed to bail out our banks at the cost of our entire societies, and B) we largely owe our debts to those same banks. So why should they let us off the hook now? They own us.

Meanwhile, even if you think that last bit is silly, how do you yourself think you can squeeze your behind out of the massive short squeeze that happened last week? By purchasing shares? Really?

 

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Tue, 10/13/2015 - 12:02 | 6662960 Bernoulli
Bernoulli's picture

A peek behind the facade

Likely a derivatives accident

I already posted this some days ago but here it is again.

Please somebody at ZH check out Credit Suisse annual report and tell me what you see.

https://www.credit-suisse.com/media/cc/docs/publications/annualreporting...) 

Let's look at the largest amounts in CHF-terms. If I didn’t miss anything, by far the largest amounts are the “notional amounts” of derivatives (page 304). The total amount (in Trading) is 51 trillion CHF (= 51’000’000’000’000 CHF?). A bit further down in the report I read that the notional amounts are given "as an indication of the volume of derivative activity within the Group". So this is an indication of the order of magnitude (on December 31st 2014?), could be 10 trillion more at times, or 10 trillion less?!? And then further down, I read that some of derivative contracts apparently don't need to be disclosed at all (under US GAAP, surprise, surprise!), if some conditions are met.

Next, we are to believe, that the “fair value” of those gigantic risks are not the notional values, but the positive and negative replacement values “the amount receivable from or payable to the counterparty if the derivative transaction were to be settled at the reporting date" or something like the cost to re-enter into the same bet if the counterparty defaults or the cost to close the position on 31st of December 2014. This doesn’t make much sense to me at all: If a company owns a building and a shareholder wants to know the biggest potential damage a fire could cause, I would certainly not report it as the cost of buying fire insurance. Or put differently: A roulette player in the casino puts 100 CHF on 36 and he reports the fair value of his bet is 100 CHF, although he hopes to win 3’500 CHF with the bet (= buying to open a put or a call option?). Even more striking: The casino takes the 100 CHF bet and reports the maximum risk is 100 CHF although the casino could potentially lose 3’500 CHF (= selling a put or a call option to open?).

But then even how are the “fair values” determined: They are "calculated" according to different levels (page 323):

- Level 1 means if I there are actually prices out there at a certain date (more or less correct?) --> less than 1% of the derivatives fall in that category

- Level 2 means there is no price but something similar is taken instead or “any other” input is available (sounds quite fuzzy) --> about 98% of the derivatives fall in that category

- Level 3 means the value is essentially made up ("reflect the Group's own assumptions") --> less than 1% fall in that category

But what remains one of the big unknowns is: How much leverage is behind all those bets, especially the Level 2 and Level 3 ones?

After this massive apparently legal (!) accounting gimmick, the next hammer hits me. These “fair value” amounts, two orders of magnitude smaller than the notional amount are not the final relevant values in the balance sheet, they are further reduced by “netting”. We read: "Derivative contracts are reported on a gross basis by level. The impact of netting represents legally enforceable master netting agreements". And "Netting agreements are contracts between two parties where under certain circumstances, such as insolvency, bankruptcy or any other credit event, mutual claims from outstanding business transactions can be offset against each other. The inclusion of a legally binding netting agreement reduces the default risk from a gross to a net amount".

This means that since Credit Suisse has bilateral contracts potentially reducing credit risks "under certain circumstances" (can those contracts be enforced? under which jurisdiction? has this process ever been legally tested?), only a small fraction of the so called fair values are shown on the balance sheet. Of the original derivatives "notional value" of 51 trillion CHF, 38 billion CHF remain on the assets side and 37 billion CHF on the liabilities side. Three orders of magnitude less. Then I am not sure, I didn’t check in detail but how does this feed into risk-weighted assets under Basel III regulations, which is again about a third of the assets on the balance sheet and the capital to be held against those which is maybe 10% of those risk weighted assets?

Does this mean that the value of capital Credit Suisse has to hold against derivatives is four orders of magnitude smaller than the notional amounts of the derivatives?

Formula for happy bankers: amount of capital necessary = notional value of derivatives / 1'000.

"Too big to fail" has been solved.

Thank you.

PS: Please apologize, I think I got the orders of magnitudes wrong in the first post. The numbers are just too high... please help :-/

 

Tue, 10/13/2015 - 12:20 | 6663113 Eigen20
Eigen20's picture

Regarding the second graph- reverse repos over calendar year 2015-

A derivatives accident??  Why are there no comments identifying all of the peaks as end-of-quarter events?  If you're a bank and have shitty debt on your balance sheet... you can repo the garbage to the Fed for cash... but the pile of cash look suspicious too so you send it back to the Fed in a reverse repo to get healthy Treasuries onto the balance sheet for quarter end reporting.  Fed alchemy ftw!

Tue, 10/13/2015 - 12:37 | 6663151 Bernoulli
Bernoulli's picture

Works until it doesn't.

Everybody here know's it, but what I'm trying to say is that the moment it doesn't work anymore, the "notional" amounts are so staggering, there will be absolutely no way of "bailing out" anybody or anything. This will be the total reset. And I'm getting scared a bit.

Anybody who thinks they can access their online "trading" accounts or bank accounts are just dreamers. Safety deposit boxes? Probably also not.

What happens if an individual goes bankrupt? Time is stopped and everything is stripped from him/her that has any value and from then on he/she has to pay all the money he/she makes to creditors for many years except for some amount for a roof, some food and TV and clothes or so.

Now think it through: What will happen if the world goes bankrupt thanks to toxic derivatives on big banks balance sheets?

There will be no "netting" that is for sure...

The scenario could well turn out much worse than even the most drastic pessimists here are predicting.

Tue, 10/13/2015 - 12:51 | 6663226 vq1
vq1's picture

dead-serious question: At what point, what sign, would you need to pull all cash out of the bank?

 

Im willing to bet- actually i am betting all the money in my checking account - that i will still be able to withdraw it tomorrow, the next day and the next day but for how long?

 

thank you.

Tue, 10/13/2015 - 13:51 | 6663436 Bernoulli
Bernoulli's picture

I'm not sure if there will be a bell ringing at the top.

Here a crazy theory (I know this all sounds like I'm a complete nut-job, but the whole "notional value" thing got me going a bit):

Imagine within the current system where you have to hold 1 CHF against the notional value in derivatives of 1'000 CHF (if my assumptions above are correct?). Let's say a derivative bet goes really bad, let's say the notional value of all derivatives of Credit Suisse drops 2% (= 1 trillion CHF). After "fair value" => a 50 billion CHF loss, after netting => 5 billion CHF loss. At the end of the day, as long as the system still works, somewhere you will need to find maybe 10% of that (500 million CHF) for the regulator.

And now two days ago, Credit Suisse says they are planning to raise 8 billion CHF (kind of out of nowhere)? Doesn't that make you go "hmmm"?

What if the real losses on the banks balance sheets at one point are staggering but can still be hidden away for some time while the house of cards is still standing? But then  someone important somewhere over the weekend finds out there are gigantic massive holes instead of "assets" within the balance sheets of CS, UBS, DB, JPM, BoAML, GS??

If this "news" will spread, do you think the "markets" would open on a Monday? Do you think your online banking would work? Do you think the ATMs would work? Hell no!

But this is impossible, you say. Yes, it sounds quite crazy. This is why my guess is that such a "discovery" would be covered up with something big. Really, really BIG. Like shutting down the internet or so ("sorry, you surely understand we can't open the bank", "sorry, the ATMs don't work due to internet being down", "sorry, all our software is not running", etc etc).

And then: bank holiday. And then as more shit surfaces: even more bank holiday.

So the answer to your dead-serious question would be: "NOW!"

(What do you have to lose? 0.5% interest payment per year?)

With the prudent approach of not putting all eggs in one basket you could

1) Buy gold and silver with a third of your wealth and "lose" it in an "unfortunate boating accident" (apparently this has happened to somebody on ZH already)

2) Put the another third of your cash in US Dollars, Swiss Franc, GBP, Rubles and Yuan Renminbi in your safe that is safely anchored in your home (http://www.swiss-safe.ch/burglary-process/safe-check-list/); preferably, you also prepped a little bit, and have some sort of gun, ammo, and you are fit to use it

3) You could leave one third on the bank in the form of bits and bytes or even some "investments", whatever.

PS: I'm not there yet, so if it happens soon, I'm a bit f***ed, too. But this is at least my plan.

 

 

 

Tue, 10/13/2015 - 14:55 | 6663710 vq1
vq1's picture

I appreciate your research and conclusions.

 

1) Luckily I already bought some physical gold. For the first time and against the advice of all my financial advisers. Before the nice little ramp up we have had. 

2) okay im going to do that, like this week. I live in a secure building and I have a fire-proof safe. Although this too, will be against my financial advisers. 

3) just in case everything is awesome!

Tue, 10/13/2015 - 15:30 | 6663863 Bernoulli
Bernoulli's picture

Thanks! But please don't blame me if there is a 10 year bull market from now on! this all is just my personal opinion....

Yes, those "financial advisers" just hate when you take chips off the table and leave the casino. They will tell you that you don't make any "return" and so on... but what should they say? They are part of a system that won't exist anymore in the same way some time in the future, so if they would have seen the light, they wouldn't be financial advisers. Or at least they wouldn't share it with their customers.

Concerning 3) --> exactly, just in case everything is AOK! And also for convenience reasons.

Tue, 10/13/2015 - 16:31 | 6664156 vq1
vq1's picture

of course. You're only one of many I have asked. 

Tue, 10/13/2015 - 13:29 | 6663291 Bastiat
Bastiat's picture

Thanks for filling in the missing step, Eigen. It's been driving me crazy.

When they talk of collateral injection through reverse repos or collateral shortages, it drives me nuts.  First, a normal, old school "reverse repo" is basically borrowing against collateral (usually treasuries or agencies).  A "repo" is simply the other side of the "reverse repo."  In the case of a reverse repo the collateral is "sold" at one price with an agreement to repurchase at another (the difference being the interest paid to the lender/purchaseer).  Think of it as a pawn. 

Looked at simplistically like this, the reverse repo from the Fed is a tightening tool, removing "cash" from the system.  The part that never made sense in the current context was:  how does this help your "collateral shortage" if you already have the "cash?"  If you have the "cash" why do you need collateral?  To borrow against so you can get your "cash" back? 

The answer is the step always left out, the one you supplied: they don't have the "cash" they need "cash" and what they have is bad collateral that can't be borrowed against---except to a certain very accomadating counterparty, the Fed.  But what is "cash?"  Cash is not paper for these guys, cash is good collateral: UST paper.  So maybe they have a derivatives exposure event and need to post good collateral to a counterparty.  They don't have enough, so they borrow from the Fed against their crap paper and then, essentially "lend" to the Fed, receiving UST paper for cash in the reverse repo.

Short version:  "collateral shortage" means insolvent.

Any corrections welcome.  Been trying to figure this out for years.  I may look simple minded, but actually I negotiated proprietary private placement repos back in the 80s for a few years.

 

 

Tue, 10/13/2015 - 14:01 | 6663471 Bernoulli
Bernoulli's picture

Thanks for the explanation.

 

Tue, 10/13/2015 - 13:00 | 6663266 Consuelo
Consuelo's picture

'CHF':

 

Congestive $Heart Failure.

 

 

Tue, 10/13/2015 - 11:36 | 6662964 venturen
venturen's picture

"QE Causes Deflation, Not Inflation

 

NO...STEALING FROM THE MANY FOR THE FEW...AND PAYING ZERO INTEREST CAUSES DEFLATION!

Tue, 10/13/2015 - 11:40 | 6662974 venturen
venturen's picture

October 13, 2015 8:30 am

China asset management executive stabbed by disgruntled investor

http://www.ft.com/intl/cms/s/0/7ff65f24-7171-11e5-ad6d-f4ed76f0900a.html...

Tue, 10/13/2015 - 11:42 | 6662981 MadVladtheconquerer
MadVladtheconquerer's picture

The 11:30 ramp has started.  Pretty tame again but evident. 

That ended quickly.  Much like the Chargers in MNF.

 

Tue, 10/13/2015 - 11:48 | 6662996 KnuckleDragger-X
KnuckleDragger-X's picture

How dare you bring reality into fairy land !!! The Fed will be printing soon, so line up now for your lead life preserver.....

Tue, 10/13/2015 - 11:49 | 6663000 PoasterToaster
PoasterToaster's picture

This business that "we" are on long downward slope forever and ever amen is getting old.  YOU may be facing the end of your non productive ill gotten gain era, but the rest of us are thrilled that shit is coming to an end.  The money masters have been standing in the way far too long as it is.

Tue, 10/13/2015 - 15:33 | 6663887 Jstanley011
Jstanley011's picture

When heating oil hits twenty bucks a gallon, the people burning their furniture to stay warm may turn out to be less than thrilled.

Tue, 10/13/2015 - 12:11 | 6663068 venturen
venturen's picture

could this be Obama filling suitcases of money and sending them to Kenya for his retirement?

Tue, 10/13/2015 - 13:06 | 6663285 My Days Are Get...
My Days Are Getting Fewer's picture

I was fishing for salmon on the Miramichi River in Canada last week.  I got a 15 lbs hen into the net and a 25% draw-down on my VXX position during my absence.

I have figured out how I caught and lost hooked-up salmon but can not figure out how a RRP translates into a short squeeze.

Could someone give me an easy to understand explanation.

I will reciprocate and help you figure out how to execute the greased line method of presenting the fly to the salmon.

Tue, 10/13/2015 - 14:25 | 6663551 hawaiianPunch
hawaiianPunch's picture

So, based on the FRED Reverse-Repo chart, "The Big One" started at the beginning of 2014. As far as I can tell there's no hope in shorting the market because if the Fed allows the collapse - it will end the system; that was proven by a mere 10% drop in Sept - and the resulting - massive - spike in reverse repos. Nothing matters now except what the Fed does or does not do. Since the "too big to fail" banks know this, they are going full retard on long derivatives, and the Fed is continually bailing them out with more and ever increasing injections. This is exactly what the Fed wants, a bubble so massive, that it can control the exact day it pulls the plug and ends it (before any shorts can profit from it). Then initiating a new world currency in a matter of days. The only prudent thing to do is invest in tangible assets that are difficult for the government to confiscate. When the system does collapse, there will be martial law and confiscation of all gold, silver, and other PM's. Get your money out of the system and into land, tools, manufacturing equipment, and houses. Property values will collapse, but the paper/digital system will become worthless.

Tue, 10/13/2015 - 14:42 | 6663636 Bernoulli
Bernoulli's picture

Recently, I thought of something:

Sturdy bicycles with trailers could actually be a good "tangible asset" to own (at least in cities and in Europe). Everybody will need to scale down and many more people will use a bike for transporting themselves and stuff from A to B. If a good bike now "costs" half your available monthly salary or even more, owning 20 or 30 functioning (new?) bikes with hassle-free equipment (without "suspension" and all that stuff) in a storage place could be quite a good thing, no? Maybe people will "pay" half a month of labor for a bike with trailor?

Tue, 10/13/2015 - 14:50 | 6663691 besnook
besnook's picture

so the fed is the model balancer of last resort. it is just digital. there is no real money involved.

 

the dumbfucks keep whining about velocity and they can't see that if money is given directly to the people who will end up with it anyway there is no reason for velocity or a multiplier therefore there is deflation for lack of demand. if money is given to the bottom it will be spent several times in several places before it gets to the top and that used to be called an economy.

Tue, 10/13/2015 - 18:54 | 6664560 vladiki
vladiki's picture

Aside from the unknown unknowns, and crummy data,  the fatal flaw in using economic theory (a la Bernanke) to manage the whole economy is our limited capacity to handle simultaneous variables.  To make it fit our brains, we FIX variables. But often arbitrarily, because we don't fully understand the relationships. or even know how reliable the data is.   The Fed might think ... "Increase X and you decrease Y" ..... but only if Z is constant .... but Z isn't constant .... X changes Z, and Z of its own changes Y ... and it's not just that increasing X increases Z; increasing X a little decreases Z in an arithmetic relationship ... but increasing it a lot increases Z in a logarithmic relationship ............

We're much too ignorant and not remotely smart enough to manage an economy this way.  It needs the ultimate empiric ...... THE MARKET.

To do its job with the skill it pretends, The Fed's dashboard would have to be  3 .. 4 .. 10 dimensional with innumerable dials including many blanks to remind it of all the unknowns, and with several guages wobbling wildly to remind them that much data is volatile, unreliable, and of dubious significance. The status quo is a farce.  The Fed assumes a wisdom it could NEVER have.  It's taken on an impossibe task.  No sign of insight - or even of much intellect.  It is frankly depressing to read Yellen and Bernanke's 'incoherent babblings'. We'll get nowhere till the Fed is put back in its place and with a single mandate - inflation control (+ lender of last resort at punitive interest rate). It is way out of its depth.

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