Submitted by David Stockman via Contra Corner blog [17],
First comes production. Then comes income. Spending and savings follow. All the rest is debt…….unless you believe in a magic Keynesian ether called “aggregate demand” and a blatant stab-in-the-dark called “potential GDP”.
I don’t. So let’s start with a pretty startling contrast between two bellwether data trends since the pre-crisis peak in late 2007—debt versus production.
Not surprisingly, we have racked up a lot more debt—notwithstanding all the phony palaver about “deleveraging”. In fact, total credit market debt outstanding—-government, business, household and finance—-is up by 16% since the last peak—from $50 trillion to $58 trillion. And that 2007 peak, in turn, was up 80% from the previous peak (2001); and that was up 103% from the business cycle peak before that (July 1990).
Yes, the debt mountain just keeps on growing. It now stands 4.2X higher than the $13.6 trillion outstanding just 24 years ago.
As a proxy for “production” I am using non-durable manufactures rather than the overall industrial production index for three good reasons. The former excludes utility output, which incorporates a lot of weather related noise, and also excludes oil and gas production, which, as we are now learning, embodies a whole lot of debt. Besides, if the US economy has any hope of growing, non-durables should not still be migrating off-shore at this late stage of the global cycle; nor are they subject to fashion or lumpy replacement cycles like cars and refrigerators.
Moreover, the virtue of the industrial production index is that it is a measure of physical output, not sales dollars which reflect inflation. And unlike indicators that are deflated into “real” terms, it is not distorted by Washington’s fudging and finagling of the prices indices.
So how are we doing on production of things the American economy consumes day-in-and-day out? Well, at the most recent data point for November, production had soared…….all the way back to where it was in January 2003!
That’s right. Domestic output of food and beverages, paper, chemicals, plastics, textiles and finished energy products (e.g. gasoline), to name just a few, has experienced no net growth for nearly 11 years.
Now that’s a lot more informative than the Keynesian GDP accounts, which presume that government output is actually worth something and that do not know the difference between current period “spending” derived from production and “spending” funded by hocking future income, that is, by borrowing.
Stated differently, the current capitalism suffocating regime of Keynesian central banking and extreme financial repression has created systematic bias and noise in the so-called “in-coming data”. These distortions are the result of mis-allocations and malinvestments reflecting artificial, sub-economic costs of debt and capital. The resulting bubbles and booms, in turn, cause highly aggregated measures of economic activity to be flattered by the unsustainable production, spending and investment trends underneath at the sector level.
Thus, during the peak-to-peak cycle between 2000 and 2007, industrial production was reported to have generated a modest 1.5% per year growth rate. But that was almost entirely accounted for by construction materials and defense equipment. Production of non-durable manufactured goods during that period, by contrast, expanded at just a 0.2% annual rate.
But, alas, defense production inherently destroyers economic wealth, whether it provides for the national security or not. And the housing and commercial real estate construction boom did not add to permanent output growth and wealth at all; it amounted to a bubble round trip that has gone nowhere on a net basis during the last 11 years. And the graph below which documents this truth is in nominal terms, meaning that real private construction spending for residential housing, offices, retail and other commercial facilities actually declined by 10-15% after inflation during that period.
Stated differently, bubble finance does not create growth; it funds phony booms that end up as destructive round trips.
Yet, here we are again. The graph below reflects production of oil and gas, coal and other mining products including iron ore and copper. It has soared by 35% since the 2007 peak, and accounts for virtually all of the gain in industrial production ex-utilities over the last seven years.
Yet the plain fact is, the above explosion of mainly oil and gas production did not reflect the natural economics of the free market, and certainly no technological innovation called “fracking”. The later wasn’t a miracle; it was just a standard oilfield production technique that was long known to the industry, if not to CNBC. It became artificially economic during recent years only due to the massive and continuous distortions of both commodity prices and capital costs caused by the world’s central bankers.
Indeed, there are two charts which capture the central bank complicity in the latest bubble distortion of the “in-coming” data. These are the charts of plunging junk bond yields and soaring oil prices which materialized after the world’s central banks went all-in powering-up their printing presses after September 2008.
At the time of the 2008 financial crisis, what remained of honest price discovery in the capital markets caused a hissy fit among traders and money managers—–who had been stuck when the music stopped with hundreds of billions in dodgy junk bonds issued during the prior bubble. Accordingly, yields soared to upwards of 20% when massively overleveraged LBOs and other financial engineering gambits went bust.
Needless to say, that urgently needed cleansing was stopped cold in its tracks when Bernanke tripled the Fed’s balance sheets in less than a year after the Lehman crisis, and then officially adopted ZIRP and the greatest spree of debt monetization in recorded history. The resulting desperate scramble for yield among professional money managers and home gamers alike caused nominal interest rates on junk to be driven to levels once reserved for risk free treasuries.
But it wasn’t cheap debt alone that fueled the energy bubble. The 10- year graph of the crude oil marker price (WTI) shown below is an even greater artifact of central bank financial repression. The unprecedented global credit expansion since 2005, and especially after the financial crisis in China and the EM, caused several decades worth of normal GDP expansion to be telescoped into an artificially brief period of time.
As a result, demand for industrial commodities temporarily ran far ahead of new capacity—–even as the latter was being fueled by low-cost capital. That’s why iron ore prices, for example, soared from $20 per ton prior to the China boom to $200 per ton at the peak in 2012, and have now plummeted all the way back to $60 ton. This implosion is still not over. Owing to this extended period of artificial sky-high prices for the iron ore commodity, the massive investment boom they triggered in mining capacity and transportation infrastructure is still coming on-stream, adding even more increments to supply even as prices plunge.
Call it “operation twist” compliments of central bank bubble finance. It embodies a temporally twisted imbalance of supply and demand that inherently results from false prices in the capital and commodity markets.
Yet this condition is neither sustainable nor stable. Indeed, now we see the back side of this central bank bubble cycle as capacity races past sustainable consumption requirements, causing prices, profits margins and new investment to plunge in a violent correction. Iron ore is just the canary in the mine shaft. The same thing is true of nickel, copper, aluminum and most especially hydrocarbon liquids.
So the oil price chart below does not represent a momentary dip. This time the central banks are out of dry powder because they are at the zero bound or close in the greater part of world GDP, while the lagged impact of the bloated industrial investment boom continues to pour into the supply-side.
Needless to say, the emerging worldwide liquidation of the energy bubble will hit the highest cost provinces first—-which is to say, the shale patch and oils sands of North America. When drilling rigs start being demobilized by the hundreds rather than just by the score—-and its only a matter of weeks and months—the present the US mining production index shown above will bend back toward the flat-line just as housing and real estate construction did last time around.
Stated differently, there is no “escape velocity” in the forward outlook—– notwithstanding the delusional expectations unloaded again this afternoon by Yellen and her merry band of money printers. Much of what meager production and job growth there has been in recent years will soon be taken back as the energy bubble comes back to earth.
Needless to say, the Keynesian pettifoggers at the Fed and the other central banks around the world see none of this coming. So once again in its post-meeting statement, the Fed majority could not bring itself to let go of ZIRP, choosing to assert that it will remain “patient” as far as the eye can see—– while presiding over a meaningless policy change which might be called N-ZIRP. That is, “nearly” zero cost money, and just as destructructive.
Needless to say, the promise of almost free money for the carry trades is all the Wall Street speculators needed to hear. Within a minute or two, the robo-traders and gamblers managed to put a half-trillion dollars of fairy-tale money back on the screen.
But here’s the thing. The meaning of the oil crash is that the central bank fueled bubble of this century is over and done. We are now entering an age of global cooling, drastic industrial deflation, serial bubble blow-ups and faltering corporate profits.
So if some headline grabbing algos want to hyper-ventilate because the clueless money printers in the Eccles Building have now emitted the word “patient”, so be it. But why would you pay 20X for the S&P 500’s bubble bloated profits which have already peaked, and which will be subject to fierce global headwinds as far as the eye can see?
Indeed, the Fed’s lunatic assurance this afternoon that the Wall Street casino will have had free money for 76 months running, and that it will remain quasi-free long thereafter only means that the current financial bubbles in virtually every class of “risk assets” will become even more artificial, unstable and incendiary.
In any event, it ought to be evident by now that “potential GDP” is a fairy tale and that N-ZIRP has no more chance of generating that magic ether called “aggregate demand” than did ZIRP. We are at “peak debt” in nearly every precinct of the world economy, and that means that central banks cannot close this wholly theoretical and imaginary gap; they can only blow dangerous bubbles trying.
What counts is production of real goods and services based on honest prices and the efficient utilization of labor and capital. And it goes without saying that cannot happen under the current central banking regime of false prices and drastic misallocation of economic resources.
The current illusion of recovery is a result mainly of windfalls to the financial asset owning upper strata, the explosion of transfer payments funded with borrowed public money and another supply-side bubble - this time in the energy sector and its suppliers and infrastructure.
But that’s not real growth or wealth. Indeed, the desultory truth about the latter is better revealed by the fact that the American economy is not even maintaining its 20th century level of breadwinner jobs.
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Breadwinner Economy – Click to enlarge
And the real state of affairs is further testified to by the lamentable trend in real median household incomes.
That figure - not distorted by the bubble at the top of the income ladder - is still lower than it was two decades ago.
So much for the Keynesian rap. Yet that’s about all that underpins the latest Wall Street rip.
