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How Peak Debt Constrains The Fed From Moving Rates Higher
Submitted by Eugen von Bohm-Bawerk via Bawerk.net,
We have argued for a long time that 2016 will probably be a year of recession in the US and the Federal Reserve’s intent on raising rates will only help expedite it. We believe the current rate cycle will be short lived as the Federal Reserve is constrained by the heavy debt load weighing on the US economy. Or more specifically, the large share of unproductive and counterproductive debt that drain the US economy for resources.
Source: Federal Reserve – Financial Accounts of the United States (Z.1), Bawerk.net
Since most added debt in the US economy, or the world for that matter, is consumptive in nature it adds nothing to the capital base and must therefore be repaid from legacy asset which were once put into productive usage. However, as the non-productive share increases relatively to the productive part, the system naturally comes under strain and will eventually reach debt saturation through capital consumption.
This process can be seen through different metrics, such as the fact that it takes ever more debt to “create” an extra unit of GDP, or the falling velocity of money; as more money get diverted toward unproductive debt servicing, less will be available for productive investments. That in turn, duly lowers GDP growth. Stated differently, lower velocity of money suggest the economy has reached debt saturation. If that’s the case, monetary policy becomes impotent. True; central bank balance sheet expansion may create the illusion that it isn’t, but that’s only because it helps to maintain funding for unproductive debt, which otherwise would be liquidated. This can only go on for so long though as avoiding consequences of reality is never a long term solution.
The fact that US money velocity has dropped to 1930s depression levels is indicative of how skewed, or mal-invested, the US capital structure has become; only liquidation of debt that cannot fund itself will cure this.
Source: National Bureau of Economic Research, Federal Reserve, Bawerk.net
Several central banks across the globe have tried to escape from this predicament by raising rates without prior debt liquidation. They all had to reverse course as debt saturated economies cannot cope with higher rates without a proper clean up. Refusing to acknowledge, or failing to grasp, that unproductive debt cannot be funded forever, higher interest rates quickly diverted too much resources away from sustainable economic activity, putting pressure on growth and thus forcing central banks to cut rates soon after they tried to raise them. When the pool of real savings are not there to support the economic structure, all monetary policy can do is to temporary sustain the unsustainable. However, as times goes by, and capital consumption continues, economic stagnation occurs even at ZIRP, NIRP and QE as all these tools can do is to redistribute capital.
Source: Bloomberg, Bawerk.net
As the Fed will now embark on the same journey, attempting to raise rates, we should expect the same dynamics to follow suit. Increasing the cost of maintaining unproductive debt will pressure the pool of real savings which in turn will push the economy toward recession. With such a fragile starting point, we are confident the Fed cycle will be short lived.
Recognizing that nominal GDP amounts to total money income, we can heuristically say that no more than 100 per cent of nominal GDP growth can go to debt servicing over the longer term without facing difficulties. In other words, the “sustainable” average rate of interest is equal to
With (unproductive) debt increasing, and nominal GDP growth consequently decreasing, it’s natural that the sustainable rate of interest is falling. We solved the abovementioned equation to get an idea of the tolerance level over time. As the next chart shows, the sustainable average rate of interest is currently below one per cent, while the effective Federal Funds rate is expected to move to 1.25 per cent in twelve months (per the FRB /US Model). Assuming some bearish flattening of the yield curve, the ten year treasury yield will be around 3.5 per cent by next year in this scenario. The only way this can be sustainable is for dollar holders to lose faith in the currency, creating enough velocity and hence inflation to push nominal GDP growth materially higher as they dump their dollar balances on the market. Needless to say, that would create a whole new world of pain in itself.
Source: Federal Reserve, Bureau of Economic Analysis, Bawerk.net
The short of it, as soon as the Fed moves money market rates upwards, unproductive parts of the economy will come under severe strain which in turn sets in motion recessionary forces prompting the Fed to reverse course. The only way out is to realize that the world is awash in mal-invested capital that need to be written off. Since that is inconceivable for today’s vested interests, the way forward will be further “Japanification” of the global economy. And this time we are all out of arrows.
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It's over. Doesn't matter what they do now.
They did have a chance to do a real stick-save back in 2009, but no... green shoots and all that stuff had to be done politically. I blame The Bernank and Obama.
Fed's actions in 2009 masked the failure of the economic policies that Obama was implementing, which the Republicans went along with in lock-step fashion. From Cash for Clunkers to the American Recovery and Reinvestment Act to Obamacare, they were all bad choices.
The Fed's masking gave Obama yet another four years to continue the bad economic choices.
Without the Fed, the politicians would have to answer for their poor economic strategies. With the Fed, we are the ones that will have to answer.
...All gonna be fine for USSA.
Yellen just gonna make a pen stroke thru line showing debts to China and Russia.
"We believe the current rate cycle will be short lived as the Federal Reserve is constrained by the heavy debt load weighing on the US economy."
What if the implied assumptions regarding the Fed's motives are unwarranted?
nice charts. i especially like the ones with all the colorful lines. ;)
Productive debt?
Not if the Fed has anything to say about it.......
Yes, productive debt. let me help...
Debt to buy a car - unproductive
Debt to buy a delivery vehicle - productive
Debt to buy merchandise - unproductive
Debt to buy inventory to be resold at a profit - productive
Debt to buy porn - productive (but thats just a personal opinion).
porn is free, no need to go in debt for that.
Markets can remain irrational longer than you can remain solvent. Translated, this means that you should max out your credit card by purchasing an armored tank at the Armored Tank Store. And before you drive it home make sure to tank up with fuel before all the banks crash.
"After a bad opening, there is hope for the middle game. After a bad middle game, there is hope for the endgame. But once you are in the endgame, the moment of truth has arrived." ~ chess quote by Edmar Mednis
"The only way out is to realize that the world is awash in mal-invested capital that need to be written off"
As long as those that created the debt are quartered and drawn, wealth confiscated including their families with their foreheads stamped. There must be pain.
All of these charts show that the central banksters are truly "pushing on a string". Time to start the helicopter money drops in earnest.
If they cannot get VoM figure turned around, we are all fucked.
I'm hoping for heavy weapons helicopter drops, like what the US .gov cartel has been doing in Syria. I need a new anti-aircraft missile system for X-mas!!!!
Great article. It explains in simple terms failed central bank, monetary, fiscal, etc., policies. Too bad boobus americanus reads at about a 6th grade level, otherwise this article should be spread far and wide.
The fact that such things as the weather and other life stuff ends up getting the blame for all things economic (besides the bloodied and battered American consumer), shows how arrogant our overlords really are, as well as the fragility of the U.S. economy.
Watch your six, this one's gonna be a doozy.
The bloodied and battered American consumer is largely bloodied and battered by his or her own doing. How much stupid money is being paid out to "stay connected?" ...(un)smartphone, cable TV, etc., and for how many years? They'd have sizable savings if they knew how to live their lives frugally, or even with a modicum of rationality. And how much foreign junk have they bought in the past decade - sabotaging their own jobs as well as others.
Oh, and the oil price has fallen along with the price of gasoline. I'd expect the average American to be lining up to buy gas guzzlers about now - financing that vehicle for record lengths of time only to be 2x4d next year when the price of fuel goes up. "Why didn't I realize that sooner?" Meanwhile, because of the low price of gas the price of small cars are probably very competitive while gas guzzlers are at near historical high prices. "Double whammy! That's for me!"
Its self destruction in motion.
Skewed on our own skewers !
Pay off debt.
Good idea. You pay the debt. I’ll show others how to repudiate debt that never received our consent.
The difference between Japan and the rest of the world is that Japan is for the most part a homogenous society with shared social values and a widespread belief, especially among Japanese political class, of Japaneseness. The Japanese collapse has been mostly a quiet and orderly decline, in part managed by outsourcing manufacturing to 3rd world shitholes, but also in part by the shared values of obligation that Japanese feel to one another. Grossly overstaffed department stores and retail outlets are still the norm, even if wages have been stagnant, most Japanese employers make some effort to soak up a large share of the labor force. There are no grand debates about Japanese identity, or some smoldering civil war between Japanese conservatives and liberals; blue prefectures or red prefectures. Like some collective osmosis shared by the entire species, the Japanese seem to understand implicitly what is expected of them.
This stands in stark contrast to our multicultural paradise where miscellaneous Europeans, various brands of Africans, 3-dozen different variety of Asians, and a cauldron of Latin American ethnicities get to squabble for the table droppings the overlords of our own rapacious ownership class have overlooked to scavenge for themselves.
Probably the best cultural comparison between--in our example--the US and Japan, is how crime works within each society. In the US, gangs are violent, fractious, and in a constant war with one another and law enforcement. Their feuds leave thousands of bodies on our streets and destroy entire cities, towns and communities. In Japan, gangs are literally.... organized. Not a single petty gangster will as much as pick a pocket without approval through his chain of command. It is literally a gross misperception that Japan is crime free. This is not true. The truth is, in Japan, crime, like everything else, is carefully managed. So carefully in fact, that Japan has the appearance of a crime free society. In it not unheard of for yakuza to cooperate with police in criminal cases when the unwritten code has been violated. Everyone implicity understands this.
Needless to add, our social decline will be of a whole different variety than what the Japanese have been going through since '89. So these sloppy comparisons are so offbase to be meaningless.
Excellent post. Zero social fabric left in the US, zero idea of the common good. Zero idea of shared values, LGBT, greens, redneck gun crazies, Muslim immigrants in Minnesota, know it all New Yorkers sniffing their own farts, know it all Silicon Valley shitheads sniffing their own farts, farmers in Iowa. Used to be at least there was a common idea called The American Dream but that died. Fascist billionaires controlling things from their private islands, healthcare carperbaggers, war-mad arms manufacturers, and the rest watching the Kardashians. We are so fucked
Good article. So someone explain to me why the 'PHD's', who 'run' the world, cannot see or undersand this?
Oh, I see. They do know. And everything they have done has been to try and 'prolong' this fraud.
Well, that seems like an executable offense to me; you know, treason and all that.
What did you say? The whole administration, congress, Wall St., K Street, the MIC, the media, the corporate elite; all of them are in on it as accomplices?
Or is it just a whole slew of 'random' mistakes gathering steam from 1913 (juiced in Aug. 1971 and primed in 1996) until now?
I wonder...(/sarc)
Problem is they'll make new make-believe arrows. Can't wait to see what kind of BS they come up with.
Trouble is Japan,China and everyone else needs America to export to.If Trump gets in,you can bet that there's going to be an instant level playing field and no more bullshit and ass-kissing from the Whitehouse.The NeoCons have destroyed America and sold out to Communists.He'll implode these guys if the pressure is needed.I'd factor in the ongoing election race into the high risk scenario because Trump gets in,it's a different ballgame and nobody knows where it will go.
Think again. No matter who Neo-Cons – actually, Judeo-Bolsheviks – put in the White House, nothing will change.
Trump, just like all others who receive mass media attention, is a faithful tool of Judeo-Bolsheviks.
Kinda makes u want to 'quivah!'
“The only way out is to realize that the world is awash in mal-invested capital that needs to be written off… And this time we are all out of arrows.”
That’s a gentle way to express the situation.
By “unproductive” and “counter-productive” debt, we discuss debt that is laid on the US Treasury – either directly (US Treasury securities) or indirectly (MBS, student loans, SBA loans, car-lot loans, credit card debt and other uncollectible paper). And this debt is as good as the Treasury’s ability to collect taxes against unborn generations of American taxpayers.
It can’t be done practically, nor constitutionally.
Governmental debt, in other words, is the process by which a generation of tax consumers financially cannibalizes following generations of tax payers – process that has been working for more than 150 years; it started with the National Banking Act of 1863.
There is enough such debt on the books to cannibalize following generations of Americans – well you wouldn’t believe the duration without studying an examination based on government-provided data, assumptions and formulas.
Let’s just say the amount guarantees the inauguration of anther Dark Age, five or ten times over.
This is what all can look forward to – except those who take historically-proven measures to protect themselves, and make criminal and useless classes accountable for the billions of lives they have ruined, or destroyed.
molon labe
- As Tyler's other article points out - with Nixon's Default in '71 they turned on the printing press
-They then sealed the deal in 1973 with the Saudis, held real wages flat and substituted EZ consumer credit for income, which drove the US Wage Rate to the point where it was no longer profitable, so manufacturing was exported.
- Now our econ is largely based on service and selling. Given the circumstanes, not as easy to dig your own ass out of a hole with this concentration of industry.
- We're pokin' that Bear pretty hard, and we laugh at his Chinaman friend.......
- From PetroDollar to CarbonDollar...central Gov....boarderless....cashless....bifurcated level of connectivity to the internet......
- History may not repeat but it does ryhme.....people often asked how the Nazi's came to power.........