Our Financial Buffers Are Thinning

Authored by Charles Hugh Smith via OfTwoMinds blog,

The fragility of our financial buffers will only be revealed when they fail in the next crisis.

While buffer has a specific meaning in chemistry, I am using the word in the broad sense of a reserve resource that absorbs the initial destructive impacts of crises or system overloads. Marshland along a sea coast is a buffer against destructive storm waves, for example.

A savings account acts as a buffer against financial drawdowns or losses of income that would otherwise quickly cascade into a full-blown crisis.

Redundancy of resources can act as a buffer. If an airline maintains an aircraft in reserve, this reserve plane acts as a buffer against the disruption to the airline's scheduled flights should one of its aircraft be unexpectedly removed from service by a mechanical failure. The reserve aircraft can replace the plane that was withdrawn from service with minimal disruption.

Stockpiles act as buffers against supply disruptions. A storage tank of oil buffers a refinery against any delay in its incoming shipments of crude oil. Supplies of food and water buffer against severe natural disasters that disrupt regional water service and food deliveries.

Credit can act as a financial buffer against unexpectedly high expenses or declines in revenue. If a tire on our vehicle goes flat during a road trip and we only have a few dollars cash, a credit card buffers the disruption by funding the replacement tire and labor.

But over-using credit can end up thinning our financial buffers. If someone starts using their credit card not as an emergency buffer but to augment their cash income--in effect, acting as if the borrowed money was a pay raise rather than a loan--their credit line diminishes to near-zero and when they actually need credit for an emergency, it's no longer available.

A key feature of buffers is that it's difficult for observers to tell if they've been thinned to the point where they can no longer stave off disruption. Outside observers can't tell if the oil storage tank is full or empty, or if an individual's credit card is maxed out or has a completely untapped credit line.

In terms of our economy, there are indications that our financial buffers are thinning to the point of failure. Millions of households have less than $500 savings--an essential, basic buffer against unexpected expenses.

Millions of households have borrowed money to make up for stagnating or declining income. Charting master Lance Roberts of Real Investment Advice published this chart showing how debt has been used to maintain households' standards of living:

Central bank balance sheets acted as buffers during the 2008-09 global financial crisis. But instead of rebuilding this buffer by letting balance sheets slowly decline (i.e. as bonds owned by the central bank reach maturity), central banks have thinned the buffer by rapidly expanding balance sheets during the current slow-growth expansion:

The ability of governments to borrow and spend during recessions is a key macro-economic buffer. But instead of slowing fiscal borrowing and spending, the U.S. government has ramped up borrowing immensely, thinning the buffer available for future fiscal stimulus:

If we survey the financial landscape for fully intact buffers, we find none. Every buffer has been thinned by the past eight years of extreme monetary and fiscal policies and financial leverage, that is, debt piles ever higher on an unchanged foundation of collateral.

All the buffers that absorbed the shock waves of the 2008-09 Global Financial meltdown have been drained or thinned to the point that they no longer have the capacity to absorb the next global financial crisis. From the outside, the "tank" may appear full, but it's almost empty.

The fragility of our financial buffers will only be revealed when they fail in the next crisis.


hackedicht Thu, 07/13/2017 - 08:20 Permalink

we are getting told that everything crashes for years. people who are listening to this bullshit have missed out on the biggest bull market for a long time and could have earned truckloads of cash.

PUNCHY hackedicht Thu, 07/13/2017 - 08:34 Permalink

Sorry to be a party pooper but as far as my limited knowledge goes nobody earned any CASH as far as J6P understands the concept.They earned a heck of lot of ones and zeroes on a PC screen and some paper but no actual cash.You only make that CASH when you want/need to sell Hackedicht. That's the time you KNOW if you have earned 'truckloads' as you put it.It's an old accounting rule called REALITY ARITHMETIC.

In reply to by hackedicht

new game Thu, 07/13/2017 - 08:53 Permalink

impaired collateral is all one needs to understand. this is what sets off the initial crisses. once impaired, the cascading effect starts. then the underlying bonds are wholesaled to last in suckers. usually fraud occurs at this point in tyme.but, Charles, with all due respect, the fed can create currency in unlimited quantities to "solve" this lack of buffer. And does the balance sheet really matter? think about it. their balance sheet can be a zillion trillion and what impact does that really have? it is segregated from the financial systems as planet mars is to earth. I keep thinking they can do anything financially and keep it under control with can kicking impact to the average business or individual.the real impact of course is an economy running on 7 cylinders and the strife the marginal plebs must endure. marginal meaning millions of people!and that is the real travesty!!!!, drugs, alcohol, and self esteem issues start destoying otherwise normal households. not to mention the fallout the childern face from all this messed up shit the elite cast upon society by their hubris.just sayin

SeaMonkeys new game Thu, 07/13/2017 - 11:17 Permalink

I agree with you. QE as I understand it swapped assets for reserves. Some of those assets were MBS's, which is a crime beyond belief. The government called 2008 a liquidity crisis, because nobody wanted to buy the worthless MBS's. It wasn't a liquidity crisis at all. It was a solvency crisis. Banks and others were bailed out by this part of QE, with the Fed creating reserves ex-nihilo to buy at more than 100% face value the worthless MBS's.The Fed's ability to create money (reserves in this case) is limitless as I understand it. Whatever limits do exist can no doubt be overcome, since they are the ones creating the rules. People think fiat money has value and treat it as a commodity when in fact it has no value, banks create it out of thin air when they make loans, and get interest on the newly created money as profit. All of this money that entered the economy as a loan makes up roughly 95% of the money supply. All of it is principle. The interest is not in the money supply at any given moment. This is why banks must continually lend more, so that the money supply can contain enough to pay interest. As I understand it, this is the significance of the credit impulse articles that Zero Hedge has been running. No increase in credit means no ability in aggregate to pay interest, which means across the board defaults.The fact that the money supply consists of debt means that there is always artificial stress on the economy to be profitable no matter what. This means that other areas of society have to be ignored or squashed because the fat bankers want their profits.Because the money supply consists almost entirely of debt this means that the entire landscape of the country is composed of projects that were executed first and foremost with the banks' profits in mind-directly or indirectly.When you open your eyes in the morning and walk about thruoughout the day, everything you see has its origins as a bank loan created so that the fat banker can make a profit.It's pretty vulgar when you think about itThe way to stop this and eliminate the need for the buffer that the excellent Charles Hugh Smith talks about is for the United States to use sovereign money-which is money issued debt free. It can't be destroyed as credit money is when it's repaid back to the banks.Sovereign money is not a commodity. It's issueance is not a result of private forces loaning it into the economy (society) as our current money is. The Fed would be taken over by the people of the United States. It would become a fourth branch of government and the ability of the Fed and Wall Street to own Washington would be severely damaged. I can imagine that people might object to this becuase they say government is corrupt-a swamp. They are correct. Right now, the Fed is literally the Wizard of OZ. This was the intention of the book by L. Frank Baum. The Fed, the banks, Wall Street are all little men who seem like giants. The participation rate in American politics is dismally low because the American people feel politically and socially impotent. Pulling back the curtain to reveal a little man is what we need. The only way to engage in meaningful political participation between the counties/states and the nation as a whole is to begin with this new fourth branch of government.Too big to fail banks would become a lesson in history books. Banks would become true financial intermediaries where they only lend deposits. No ex-nihilo lending. No fractional reserve lending. Since 1913, the Fed has relied on credit growth to increase the money supply to create what becomes the interest on loans. This would cease. The money supply would become a function of the fourth branch of government and serve the needs of the American people and firms, especially small and medium sized businesses.Business cycles, boom-busts are mostly a result of too much credit. This would stop. There are other reasons for business cycles that are more organic to the activities of people and firms. This is separate from the destructive bank credit issue. 

In reply to by new game

Hume Thu, 07/13/2017 - 09:00 Permalink

The buffer that matters is household balance sheets.  And these are in the best shape they've been in a a long time. Disposable income/debt ratio is very low.  Households are not debt laden.