Bernanke’s Remedy: Pump More Blood Into a Corpse

By Mike WhitneyInformation Clearing House” — Credit is everything. Without credit expansion there’s no recovery because there’s no pick-up in overall demand. But credit growth is going backwards. The banks have tightened lending standards and the pool of credit-worthy applicants has vanished. Bank lending is off 14 per cent since October 2008. Private credit is presently decreasing at a 10.5 per cent annual rate. The situation is getting worse, not better.

October 05, 2009 “

From the UK Telegraph:

“Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation…

“Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an ‘epic’ 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

“’For the first time in the post-Second World War era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew,’he said. (Ambrose Evans-Pritchard, “US credit shrinks at Great Depression rate prompting fears of double-dip recession”, UK Telegraph)

Foreclosures, delinquencies and defaults are all up. Foreclosure activity is currently at 300,000-plus per month and rising. A huge shadow inventory is being kept off-market to maintain prices. The drip, drip, drip-effect of excess inventory dumped onto the market will keep housing in the doldrums for a decade. Homeowners are unable to borrow on underwater homes. Everything points to a long-term slump in spending.

Corporations are finding it harder to roll over their debt, bank loans are defaulting at a historic pace, and commercial real estate is imploding. Credit destruction is unprecedented, massive and ongoing. The capital hole is bigger than the Fed and bigger than the Treasury. It can’t be plugged with liquidity alone.

For now, the government can fiddle GDP with $800 billion infusion of stimulus, but what happens when the political will for more deficit spending dissipates? What happens when foreign investors demand the Fed stop writing checks on an overdrawn account?

The Fed has fixed nothing. The banks are still underwater, output is at record lows, and unemployment is climbing towards 10 per cent. Fed chair Ben Bernanke’s multi-trillion dollar rescue programs have kept a wobbly system upright, but nothing more. The economy’s underlying problems are still the same. The Fed’s quantitative easing (monetization) program has sent stocks surging, but done nothing to stimulate the economy. That’s because equities bubbles have negligible impact on aggregate demand; there’s no knock-on effect. The real economy is still flatlining while Wall Street parties on. Bernanke’s plan has been a total wash.

The government cannot deficit spend forever. Eventually, GDP will have to depend on wage growth and credit expansion. Given the political and institutional bias against labor, (and opposition to wages that rise with productivity) the only way to fuel the economy is through credit growth. And there’s the rub. Households have lost nearly $14 trillion in wealth since the crisis began and are in no position to resume borrowing at pre-crisis levels. Consumers are cutting back on spending and paying down debt. They have no other choice.

This is from Bloomberg News:

“Americans plan to refrain from boosting their spending even after the biggest drop in consumption since 1980, signaling concern about the direction of the economy over the next six months.

“Only 8 per cent of U.S. adults plan to increase household spending, almost one-third will spend less, and 58 per cent expect to ‘stay the course,’ a Bloomberg News poll showed. More than 3 in 4 said they reduced spending in the past year.

“Underscoring consumers’ austere attitudes, 77 per cent of respondents said they have cut back on spending during the past year, 59 percent said they have made a bigger effort to pay off debts and 48 percent have put more money aside as savings.” (Bloomberg News)

Savings are up and spending is down. The economy is headed into a long-term funk; the “new normal”. The Fed’s sleight-of-hand programs and Obama’s stimulus elixir haven’t changed the prevailing downward trend. If anything, they have made matters worse. Consider this from Janet Tavakoli, author of “Dear Mr. Buffett” in an interview with Max Keiser:

“Regarding the outlook, my analysis is grim. I am not a doomsayer, I follow the cash, and so far, I’ve been correct, and the government has been wrong. Here’s the situation. We are at greater risk of a total meltdown due to a deflationary collapse than we were in 2007. After the greatest Ponzi scheme in the history of the capital markets, we’ve seen history’s greatest fiscal and monetary expansion, but it hasn’t worked. Debt levels of consumers and business exceed the capacity to repay.” (Janet Tavakoli On The Edge With Max Keiser)

The Fed has done nothing to restructure the financial system so the same problems which killed Lehman and thrust the global economy into a tailspin, persist today. When the stimulus runs out and the Fed ends its $1.25 trillion purchase of (Fannie and Freddie) mortgage-backed securities and $300 billion in US Treasuries, interest rates will rise, housing prices will tumble, and the economy will nosedive. Bernanke will be forced back to the printing presses, the only hope for reversing the deflationary spiral. This will trigger the next crisis, a run on the dollar.

This is from an article by Alice Schroeder of Bloomberg News:

“In all the talk of inflation because the Treasury is printing so much money versus deflation because it may not print enough, there is one type of inflation that is rarely discussed. This is the mega-inflation caused by a sudden currency devaluation. Currency is like any financial innovation, an obligation secured by assets. When the obligation is perceived to have increased far beyond the level justifiable by the assets, which in this case make up a country’s economy, a bubble has formed……Right now, the American economy is worth less than the value implied by the market value of its obligations.” (Gold Tells You U.S. Bubble Hasn’t Popped Yet: Alice Schroeder, Bloomberg)

The system crashed because it was built on the false assumption that an unregulated shadow banking system could generate an infinite amount of credit without sufficient capital. This proved to be wrong. Capitalism requires capital. The trillions of dollars in loans, complex debt-instruments, off-balance sheet operations and derivatives contracts were all stacked atop a tiny scrap of capital which eventually collapsed beneath the weight of the debt. This system (securitization) which created the mess, cannot be restored. It required a strong currency, artificially low interest rates, and credulous investors who were unaware of the inherent risks of illiquid assets. Those conditions no longer exist, nor have they for more than two years. Even so, the Fed continues to pump blood into a corpse hoping for some fleeting sign of life. This is why an even bigger crisis cannot be too far off.

Link to Article

The Death of American Capitalism

Eric Fry, reporting from Laguna Beach, California…

“Little else is required,” Adam Smith, author of The Wealth of Nations, once remarked, “to carry a state to the highest degree of affluence from the lowest barbarism but peace, easy taxes and a tolerable administration of justice; all the rest being brought about by the natural course of things.”

But this quintessentially laissez-faire perspective gains very little traction in modern-day America. In fact, it gains no traction whatsoever, except in a few fringey financial publications. Instead, America’s political elite conspires with the Wall Street bourgeoisie to lead the nation from the highest degree of affluence to the lowest barbarism.

The process begins innocently enough in the name of “crisis management,” as the political elite provides multi-trillion-dollar guarantees and bailouts to the Wall Street bourgeoisie. The proletariat embraces these bizarre, counterintuitive remedies because they genuinely believe these “remedies” contain curative powers. In other words, the proletariat believes that bureaucrats and politicians, following the self-serving recommendations of inept finance company executives, can deploy taxpayer dollars to the benefit of the masses.

Include us out.

The bureaucrats and politicians lack the requisite skills; the Wall Street bourgeoisie lack the requisite morality. Like a meeting between coyotes and butchers, nothing good could ever come from close interaction between Washington and Wall Street. If the butchers suggested converting all felines into meal, the coyotes would simply yelp and howl their approval

Your editors here at the Rude Awakening would prefer that the coyotes and butchers not conspire with one another. No one benefits….other than the coyotes and the butchers.

But what’s the use of complaining. We try never to complain, merely to understand. We try to identify and anticipate the key influences that are operating upon the financial markets. Identifying the key influences is usually not that difficult. But determining the effect of these influences is often very difficult.

During the last several months, for example, investors have been greeting the daily barrage of bad economic news as GOOD news for the stock market. We are not exactly certain why this would be so, but we are familiar with the daily banter of various financial news media. Therefore, we have encountered, ad nausea, phrases like, “better than expected,” “green shoots of recovery,” and “credit markets improving.”

We have encountered these phrases, and we have thoroughly and completely rejected them. We do not believe these phrases contain a single atom of validity, nor a single molecule of data that will produce a profitable investment result. That said, we should point out to the newest readers of the Rude Awakening that your editors have been wrong before…and may be again.

But we won’t let that stop us. The stock market’s splendid rally during the last three months was a classic bear market rally. The S&P 500, the Dow Jones Industrials and the NASDAQ Composite all rallied more than 40%. But great big rallies like these are not rare during great big bear markets.

As we pointed out last week, Japan’s Nikkei 225 Index rallied more than 40% on ten different occasions during the last two decades. And yet, the Nikkei remains more than 50% below the all-time high it established in 1989.

Could a version of this sorry scenario unfold here United States? Sure. Why not?

The nearby charts place the recent rally on Wall Street in a “Japanese context.” The chart above compares the first 20 months of our current American bear market to the first 20 months of the Nikkei’s bear market. The chart below places this 20-month period in a 20-year context. If the American stock market were to have the misfortune of mimicking the Nikkei, the road ahead would be long and painful.

Your California editor is not predicting such a scenario. But neither does he believe that “Happy days are here again.” The road ahead – both for the economy and for the stock market – is likely to be long and painful. How long and how painful is anyone’s guess. Our guess would be: Not as bad as Japan’s experience, but much worse than most Americans currently expect.

The chart above may contain a helpful glimpse into the future we fear. Despite the fact that most investors believe the worst of the recession is behind us, the nation’s employment situation is far worse than anything we have endured during the last five recessions.

So you tell me, are things getting worse or are things getting better?

The only thing we know for certain is that government intervention increases by the day, Wall Street’s malevolent influence increases by the day, the pressure to raise taxes increases by the day, the nation’s monstrous indebtedness increases by the day, threats to the dollar’s vulnerabilituy increases by the day, and therefore the long-term viability of America’s legendary capitalistic dynamism DE- creases by the day. For more on this topic, please read the column below.

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The Death of American Capitalism
by Dr. Marc Faber

When I consider that prosperity is created by “peace, easy taxes and a tolerable administration of justice,” I begin to fear that the U.S. and other Western governments are doing their very best to impoverish their countries.

A friend of mine, Michael Berry, whose missives I always read, could not have phrased this idea better than in “Importance of the Individual”, a recent report in which he quotes Milton Friedman in a 1979 interview by Phil Donohue.

Berry writes: “On February 11, 1979, Milton Friedman took two and a half minutes to explain the critical importance of the individual and choice in the free enterprise system to a doubting Phil Donohue…The individual’s freedom and ability to choose and take risks to create value are, of course, all-important life elements and a cornerstone of our country…

And yet, Berry continues, “Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual…This is not, ‘Change We Can Believe In.’ It is ‘change we must be wary of.’ Where is Milton Friedman when we really need him? Think carefully about the following interview which was conducted 30 years ago:

‘Phil Donohue: When you see around the globe the mal distribution of wealth, the desperate plight of millions of people in underdeveloped countries. When you see so few haves and so many have-nots. When you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism? And whether greed is a good idea to run on?

‘Milton Friedman: Well first of all tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fella that’s greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kind of societies that depart from that.

‘So that the record of history is absolutely crystal clear, there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.

‘Phil Donohue: Seems to reward not virtue as much as the ability to manipulate the system.

‘Milton Friedman: And what does reward virtue? You think the Communist commissar rewards virtue? You think a Hitler rewards virtue? Do you think… American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of political clout? Is it really true that political self-interest is nobler somehow than economic self- interest? You know, I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don’t even trust you to do that.’”

Certainly, you won’t find any angels at central banks around the world or in the Economics faculties of universities. I needed quite a stiff drink after reading a recent Wall Street Journal article by Harvard Professor Gregory Mankiw, who advocates creating negative real interest rates through inflation and seems to have great sympathy for the outright expropriation of savers’ capital.

Professor Mankiw declared his faith in the curative powers of inflation in February 1, 2000 article in the dead Wall Street Journal. “When you look at the mistakes of the 1920s and 1930s,” he said, “they were clearly amateurish. It is hard to imagine that happening again – we understand the business cycle much better.”

The current Federal Reserve Chairman, and of a very large number of US economists, share Mankiw’s perspective – a perspective that he reiterated in a very recent Wall Street Journal piece, entitled, “It May be Time for the Fed to Go Negative” (Wall Street Journal, April 19, 2009).

“With unemployment rising and the financial system in shambles,” Mankiw observes, “it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. [He means negative interest rates]…Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

Inflation is the answer says Mankiw – a Goldilocks style of inflation that is neither too hot nor too cold.

“Ben S. Bernanke, Fed chairman, is the perfect person to make this commitment to higher inflation,” Mankiw concludes. “Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.”

Unfortunately, inflation is a wolf in sheep’s clothing. It seems relatively tame and friendly. But it is quite the opposite. Inflation leads an economy down the path of impoverishment. If a government is determined to create inflation, there is really nothing standing in the way of its doing so.

Nevertheless, an investor can – and should –take precautions. When governments speak openly about creating inflation as a cure for macro-economic ills, the seeds of economic malaise are already germinating.

Gold anyone?

The Economy – Political Dreamland

On to Moscow!
By Bill Bonner

Last week, the European Central Bank squared its shoulders and joined ranks of the damned. The Times of London reported that in joining up with the US Federal Reserve Bank and the Bank of England, the European Central Bank “pulled out all the stops” in their drive to revive their economies. The ECB announced that it will cut its key lending rate to its lowest level ever and begin a form of “quantitative easing,” in which it will buy corporate debt in order to reduce commercial interest rates. Details to follow, it said. “Stops” are to central bankers what safety fuses are to electricians. You may take them out when you really want to get the juice flowing; but your house might burn down.

But thus did the European troops pull out the stops and get under- way. Reluctant allies, they set off to join the battle against capitalism…with no reliable maps…with insufficient supplies and a strategy elaborated by incompetents. Of course, the gods must have laughed at Napoleon too. His armies had been cut off and destroyed in Egypt. Then, his Peninsular Campaign was a disaster. But the plan to attack Russia topped them all; even the draft horses must have snickered.

It doesn’t seem to bother the Europeans that their American commander is the same fellow who failed to spot the biggest bubble in history until it blew up in his face. Nor that their field marshal has no idea of the lay of the land; nor that anyone on either side of the Atlantic seems to know where they are going; nor that, wherever it is, it will cost more to get there than they’ve got.

This week the Obama government revealed its new budget deficit. If nothing goes wrong, it will reach $1.84 trillion this year – nearly 400% of the record set last year. In 2009, the US government will borrow 50 cents for every dollar it spends. Accumulated deficits to 2019 will reach $7.1 trillion, says the forecast. Moody’s was so alarmed it warned that the US may lose its Triple-A bond rating, which it has had since 1917.

But even as bad as it looks, Obama’s budget map is still fanciful – its mountains are made of whipped cream and its rivers run with Scotch. It imagines a loss of only 1.2% of GDP in the current downturn…and a quick return to growth, with a 3% increase in 2010. Yet, the last report showed the US economy contracting at a 6% annual rate. As for growth in 2010…where would it come from? Consumer credit is falling at its fastest pace in 18 years. Consumer incomes are falling too – down 1.2% in the last 12 months. If there were any lasting consequences of this downturn, opines the New York Times, it is likely to be the “shift to savings” by the US consumer.

Meanwhile, businesses aren’t exactly hankering to spend either. Even if they had the money, businesses wouldn’t expand; they don’t have to. Spiders build their webs on America’s remaining assembly lines with little risk of being disturbed; one out of every three factories is quiet. Until existing capacity is put to work, businesses will have no power to raise prices and no need to add to their facilities.

And yet, Napoleon Bernanke is upbeat. The troops will be home “before Christmas,” he says. But the central banks’ calendars are no better than their maps. In 2004, Mr. Bernanke credited improved monetary policy with having created what he called “the Great Moderation” – the period of strong growth and low-inflation since the mid-’80s. Specifically, he was referring to the Fed’s policy of ‘inflation targeting,’ which presumes that the inflation numbers carry all the information the Fed needs to guide an economy.

This was the map the Fed was using seven years ago. Then, a tiny recession took GDP down to all of 0.2% over an 8-month period. The Fed panicked. Its emergency policy pushed the fed funds rate well below the rate of consumer price inflation and left it there for two years. This was not merely a slight miscalculation. It was a fatal strategic error, say professors Carr and Beese of the University of Akron. Not only did the Fed’s map fail to warn them; it actually sent the economy over a cliff:

The low interest rates signaled…that credit was inexpensive and readily available…[then] the Federal Reserve moved from a low accommodative interest rate policy to one of a steady and consistent increasing of interest rates between 2004 and 2007…and became a prime cause of the financial services mortgage crisis of 2008.

Today, central banks use the same computers, same theories, and same maps they had seven years ago. With these feeble instruments, they set out to go where no central bank has ever gone before – borrowing, inflating, and intervening on a scale that would have been unimaginable a few years ago. Where will they end up?

We will take a guess: this grande armee sets off on the road to recovery with the wind at its back; it will end up in Moscow with snow on its face.