Posted on 01/03/2009 6:59:11 AM PST by TigerLikesRooster
Tuesday, December 30. 2008
Posted by Karl Denninger at 08:30
Uh Oh..... Monetary Flat Spin
That has gone "just below" 1.0.
What is this?
I could go through the derivation of how money supply works in a fractional reserve monetary system (any), but won't, because most readers would have their eyes glaze over.
The important part of this graph is what it denotes. Bernanke has lost control of "N" (or velocity), which is the actual knob that he is trying to diddle when borrowing rates are changed (and in fact its the market that sets that, despite his protests.)
In fact the most useful tool in The Fed's box in terms of influencing monetary policy is the soapbox, that is, jawboning (whether it be by cajoling or threatening.)
The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity. That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy.
The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar.
If you remember the "GDP for each dollar of debt" graph....
M1's multiplier going below 1 strongly implies (but does not yet prove) that we have reached that "zero hour".
Why? Because all money is in fact debt; this is inherent in all modern monetary systems.
When Bernanke "creates" money he is doing so against an asset - that is, he is issuing debt. A Federal Reserve Note (whether electronic or paper) is in fact effectively a bond of zero maturity and indefinite expiration against the future tax collection capacity of The United States.
That is, it's a treasury bond (via a circuitous route)
The paradox that Bernanke is in danger of discovering (the hard way) is the paradox of a pilot who finds himself in a flat spin. As the ground approaches he wants to pull back on the stick but if he does so, the spin simply tightens as the wings are not producing lift - the angle of attack is too high, not too low. As such if he does what his brain screams at him to do instinctively, he dies.
Or the scuba diver who sucks on the reg and gets nothing. Your instinct is to hold your breath and kick for the surface. If you do it you die.
In both cases your only hope of survival is to do exactly the opposite of your instinct. In the case of the pilot you must not only give counter-rudder (to stop the rotation) but also push the stick forward. In the case of the diver you must exhale that last breath you have in your lungs, knowing there are no more in the tank while you kick to ascend.
If you succumb to instinct you are dead. Really dead, as in splat (or exploded lungs.)
Bernanke is effectively in the same box. The foundation of his entire thesis as a banker is that a central bank can always reverse a deflation by printing money. Unfortunately as he has done so velocity has fallen and the multiplier has now gone below 1. If this induces him to do even more of what caused this decrease there is a very real risk that the actual market reaction will be to tighten the monetary flat spin.
This is because the underlying problem in the economy isn't the lack of debt (money) in the system. It is that there is too much debt of all sorts, and since money is in fact a form of debt, you can't fix the problem by playing helicopter drop!
As I have said for more than a year the only way out is to force the bad debt out into the open and default it. Yes, this will produce bankruptcies - lots of them, including some for "inconvenient" people like Paulson's buddies on Wall Street.
But until and unless that happens adding more debt to the system depresses the multiplier effect of that debt on circulation further, and harms, rather than helps the situation.
I don't expect our government officials to understand the math on this, nor would trying to go through it help 99% of the readers, but unfortunately, mathematics is the only true science - and you can't twist it, no matter how hard you try.
Bernanke knows this at an intellectual level, just as the diver - or pilot - knows that if he holds his breath (or pulls the stick) he is going to die.
The question now becomes whether Bernanke can overcome not only instinct but also political pressure to do the wrong thing and instead use his intellect - and the math - to do the right thing.
What is the right thing? Paradoxially, it is to withdraw liquidity and by doing so force the bad debt into the open where it does (and must) default.
How far can the above ratio contract before we cross an "event horizon" from which there is no escape?
I don't know.
But I do know that there is a "too late" point, as there is for all such things, and that we are approaching it, as I have been saying for months.
BTW, evidence that Bernanke's Monetary Flat Spin is already impacting the economy in ways that may do critical (if not fatal) damage was found this morning in the Case-Schiller numbers. Everyone, including Bernanke, was expecting the rate of home price declines to start to slow in the second half of the year. Instead, they accelerated.
We're in uncharted territory folks, and the forecast is for dark-and-stinky storms.
Buckle up.
PS: Congress, and the rest of America, can't say they weren't warned. They were - right here.
Ping!
but bernanke was hired because he specialized in the great depression, right?
/s
Karl D. is now on my daily must-read list, along with Mish and some others.
Gee, aren’t you a little ray of sunshine...
There it is right there. Better a depression for the world than bankruptcy for any of the inconvenient people.
And in each the federal budget analysis issued each year.
Interesting. Thanks for posting.
Faster than a speeding bullet velocity, more powerful than a locomotive...it’s DEBTMAN!
If they really wanted to turn this thing around, they would begin raising Fed Funds and not stop until they hit at least 5%.
I think we’re in an inverted situation where raising rates will actually increase the supply of credit while stoking inflation a bit.
Additionally, the more apocalyptic these predictions become, the more confident I am that we are at or near or just past the bottom.
Fiscal policy can be either tax or expenditures changes. However, given the current state of the economy, the only long run solution is a meaningful, sustained, and permanent cut in taxes. What's really needed is tax relief at the upper income brackets, but because so many people have a deadly case of penis envy, that's not politically viable. So, how about a 33% cut in all tax rates across the board. Then everyone gets a break (even though the lower 40% pay no taxes now anyway). This would give everyone a real increase in takehome pay that would allow them to increase demand for good and services. This makes it profitable to hire more workers.
I would also cut the corporate taxes to 10%. Corporations don't pay taxes, consumers do. If we cut corporate taxes to that rate, we'd have companies in Europe and the Pacific Rim racing to set up new plants here...more employment and probably more gov't tax revenue even thought the rate was decreased.
In short, the Fed needs to go home and take a rest and gov't need to realize that corporations are the good guys and the consumer is the key to making things get back to normal. However, with a Marxist at the helm, I'm not optimistic.
I think the analogy should be a stall/spin where opposite rudder and down pressure on elevator, to increase airspeed and lower angle of attack, is the better analogy. Other than that, I agree with the article.
Where is Milton Friedman when we need him?
Bends ping!
Good comments.
This article highlights the velocity of money. This seems to be a good time to remember the equation MV=PQ (money time velocity equals the price level times quantity). If we want don’t want quantity to fall further, we should welcome a fall in the price level. In a similar situation, FDR worked extra hard to keep prices from falling. I hope we don’t repeat that mistake.
We'll see. Mr. Bernanke is an expert on the Japanese responses to their bubbles bursting and subsequent problems. My own guess is that Mr. Bernanke will use their methods, not Mr. Denniger's.
The perfect time to buy is when you are too embarassed to tell your friends and family what you just bought.
How ironic is that?!
Counter-intuitive, but correct.
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