It looks as though the US stock market is in the process of topping out. But if you’d bet heavily on a bear market, each time you saw one coming, you’d be broke by now. We will wait to see what happens…
Meanwhile, we are still puzzling over the miracle produced by the Fed.
Yuri Geller could bend spoons. The Fed bends the entire economy. Hardly a single price is unaffected. Hardly a single business plan or investment strategy goes forward without an eye on the central bank.
Jesus turned water into wine and multiplied loaves and fishes. But the Fed make the Nazarene seem like a two-bit shell game hustler. The loaves and the fishes couldn’t have had a market value of more than a few thousand shekels!
Ex nihilo nihil fit
Compare that to the Fed. It helped usher in $33 trillion worth of goods and services – out of nothing. Yes, dear reader, that is the total amount of purchases made over the last 30 years… on excess credit.
We say “excess” because it is above and beyond the level of credit that had existed – relative to GDP – for many decades before. Roughly, from 1900 to 1970, the US had $1.50 for every dollar of output. Now, there is about $3.50 per dollar of GDP. The difference, over the last 30 years, is about $33 trillion.
Where did all that bounty come from? That is the question. Can something really come from nothing? Ex nihilo nihil fit (nothing comes from nothing). And yet $33 trillion worth of “stuff” seemed to have come from out of nowhere.
It didn’t come from savings; the savings rate went down during this period. It didn’t come from earnings, either. Wages and earnings – in real terms – barely rose since the 1970s.
How about from an increase in productivity or output? Nope. As we have seen, compared to output, this “wealth” grew much faster.
That leaves only one possible source…
You may think banks lend out savings. Un un. In the modern fiat money-based economy, they create credit out of thin air. The money supply goes up when the banks see fit to make loans. And banks no longer set aside meaningful reserves against their loans. So, the limit to new credit is… well… limitless.
This entire system is created by and presided over by the Fed – a public cartel of private banks. And that’s a worry. Because, as we put it last week, the Fed’s theory – that it can build real wealth by increasing credit faster than GDP forever – is “childishly naïve.”
An old friend, Pierre Lemieux, wrote in with the following comment:
The production of things is not done with money, but with real resources. If I see a car, I know it has been produced with steel, aluminum, plastic, labor, etc. That‘s the real side of the economy.
We get on the financial side when we ask how this production was financed, that is, how people were motivated to release control of real resources. In most cases, they are motivated in doing so by receiving in exchange claims to other resources or consumer goods. Finance is the domain of the exchange of claims to real resources.
The question, then, is in which circumstances does money (a very liquid claim on real resources) help production (by reducing transaction costs), hinder it or, as you point out, create gainers and losers?
When Credit Turns Bad…
In a better world, credit depends on savings… which represent real resources. This restrains credit growth, because there are only so many real resources… and only so much savings representing them.
But in the world created by the Fed, credit has no savings behind it. It is just notations in the banking system… with no effective limit on the quantity of credit available.
That is how $33 trillion came to exist. It pretended to be real savings… representing real resources… which were then put to work to make the autos and houses that people wanted, but couldn’t afford.
In other words, the system created new claims on resources… which drew resources into the real economy. Neither past earnings (savings), nor current earnings (output) supported this economic expansion. Instead, it was all a claim on future earnings.
This is all a way of saying the obvious: If future output cannot keep up with this $33 trillion of excess debt, this debt must go bad.
That is, of course, the problem. The economy limps along… even with $1 trillion of extra QE money per year. It depends on more credit and more debt just to stay in the same place.
Every year, more resources must be drawn from the future and enjoyed in the present. Every year, the claims on future earnings increase… and every year the debt becomes even more unsupportable.
Somehow. Someday. Those claims on the future will be marked down.
When Will the Credit Party End?
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
The Fed is able to keep interest rates on the floor, and the credit machine whirring and churning, because the consumer price index has been flatlining.
But consumer prices firmed last month, as housing and food costs rose – a sign that inflation may be stirring again.
In March, the Consumer Price Index rose 1.5% year over year – up from a 1.1% year-over-year rise in February.
That may not sound like much. But the Producer Price Index – which measures wholesale prices and feeds into high consumer prices down the line – is also showing signs of renewed life.
This has even got the attention of the Fed. St. Louis Fed president James Bullard, who recently noted:
One thing you can say is that while inflation has drifted down… it kind of bottomed out in the past nine months, and I think it’s poised to go higher, back towards our target.
If Bullard is right, it will come as a shock to investors who are betting on ultra-low interest rates as far as the eye can see.
It could also bring the credit party being enjoyed on Wall Street to an abrupt end.