Now our nerves are settled. We can sleep at night. There’s nothing more to worry about. Christine Lagarde, head of the IMF, has reassured us.
Madame Lagarde tells us that further scaling back of QE won’t mean a thing, as long as the Fed goes about its tapering in a gradual, measured way, which of course it will.
“We don’t anticipate massive, heavy and serious consequences,” she said.
She must be wrong about that. If the Fed were to continue to cut back its bond-buying, the stock market and the economy would go into withdrawal shock. The economy would wobble. Stocks would fall. And Janet Yellen would promptly go into a huddle with other Fed governors and come out with an announcement: more QE!
A New Depression?
We don’t know whether Madame Lagarde is aware of it or not. Fed economists must be. They must know that the only thing keeping the economy from slipping into recession is the Fed’s EZ credit.
The following figures were shown to us by economist and author of The New Depression: The Breakdown of the Paper Money Economy, Richard Duncan. He spelled it out for us…
Since the 1980s, we have had an economy that grows on credit. In 1964, the global economy owed only $1 trillion. By 2007, total global credit had expanded to $50 trillion. The global economy depends on it.
But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one.
When credit growth slows, so does the economy.
How much credit growth does it take to keep the economy chugging ahead? Duncan says it needs an increase of at least 2% after inflation, or the economy goes backward. Every time credit growth has fallen below 2%, he says, we have had a recession. No exceptions.
A growing, expanding economy naturally leads to more credit. Households borrow for new homes and appliances. Businesses borrow for new plants and machinery. Investors borrow to finance startups and speculations. Government borrows, too, to cover deficits. And all this borrowing is what leads to new demand, new jobs and new output.
But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one. The real economy limps along. Real per capita disposable income has risen just 0.7% a year over the last five years. The personal savings rate is only 4%. (It was 10% in the 1980s.) And although the consumer deleveraging cycle is over (for now) much of the new credit creation is once again in the subprime category. (Last year, Wall Street secured $20 billion in subprime auto loans!)
Although the Fed has been unable to do much about the real economy… in the financial economy it’s wrought wonders! That’s the secret to understanding the markets, Duncan explains. It depends on the difference between how much credit the economy needs and how much it gets. The excess is what drives up asset prices.
The Rich Get Richer
That’s why the rich have gotten so rich lately…
The markets take excess credit and use it to bid up asset prices. Stocks rise. Real estate prices go up. (The average house price is back at over $200,000.)
Household net worth – heavily concentrated in the upper reaches of the socio-economic pyramid – rose $8 trillion in the last 12 months. It’s now greater than it was in 2007. And that huge increase appears to be the only thing keeping the economy from sinking.
Take away the QE, and you take the biggest single buyer out of the bond market. Bond prices fall (and yields rise). Stocks fall. Housing prices fall. And the economy, no longer buoyed up by the phony “wealth effect,” is suddenly pulled under by a real “poverty effect.”
Duncan tells us that all borrowers put together are likely to ask for $2.2 trillion worth of credit this year. That is a 3.8% increase. But that’s before inflation. Take off 2% for rising prices, and the real increase falls short of the 2% needed to avoid recession.
So, here’s what happens. The Fed has to keep peddling cheap credit, or the economy falls into recession. Some of it is absorbed by the bond market (mostly US federal deficits). Anything more than is needed to fund credit demands is the “excess liquidity” that drives the asset markets. Stocks soared in 2013 because the Fed overfunded US credit demands (the US budget deficit declined).
“The Fed is driving the economy,” says Duncan.
The feds broke it. Now, they own it.
Over the next six months, Duncan sees no problem. There will be enough excess liquidity to keep asset prices moving up.
But then, watch out.
What Does the Surge in Margin Borrowing Mean for US Stocks?
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
Margin borrowing is on the rise…
When investors borrow “on the margin,” they borrow money from their broker to buy stocks.
This is what Wall Street types call “leverage.” Margin borrowing allows you to buy more shares than you would otherwise be able to.
As you can see from the chart below from Bloomberg, margin borrowing has now surpassed its pre-crash 2000 peak… and also its pre-crash 2007 peak.
This is worrying for two important reasons…
First, investors borrow on the margin when they’re hyper-bullish on the prospects of further stock market gains. And as the father of contrarian analysis Humphrey Neill put it, “When everyone thinks alike, everyone is likely to be wrong.”
Second, margin borrowing requires investors to put up stock as collateral for their loans.
That means if stocks plunge, so does the value of investors’ collateral. This can put leveraged investors in the position of being forced sellers, if stock prices fall, as they try to maintain the value of their margin accounts.
Contrarian-minded investors would be wise to take note.