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.
I agree, but stronger. Stop taxing corporations AT ALL, and toss out the capital gains tax, too. Let people that earn this money keep much more of it, and have the government spend LESS.
It’s a very interesting article. It has data (!) which is very welcome. It is well and entertainingly written. I think the author is right that there should be bankruptcies. This is all written from a money perspective, but I don’t see this as just a money problem.
Why has velocity dropped? Irrational pessimism? The press has tried done their best to talk down the economy ever since Bush became President. Maybe they finally succeeded. I think I’m just beginning to see some efforts to talk things up, presumably for Obama. We might see some major cheerleading in 2009.
What about housing? How can one have a national housing bubble without a national force? Austrian economists point to easy money as a precursor for too much credit, too much building, and then a crash. They may have pointed out an episode of too much money, but I missed it. Anybody have a link?
Between HUD, CRA, Fannie, Freddy, and Congressional “oversight,” the Government pushed too hard for “affordable housing.” Oops. I see this as the main culprit. What’s the answer now? Build more housing? I don’t think so. I think the government should do nothing as house prices fall.
How about bailing out the states? I hear the less responsible states want a trillion dollars. I think the Austrians would say no, as do I. If we reward mismanagement now, why will anyone manage better in the future? Today’s liquidity is tomorrows bubble.
How about massive Federal spending to replace a shortfall in private spending? The author’s metaphors about pilots and divers may apply. The more the government steps in, the more consumers and investors will back away. Consumers may see this as confirmation that the great depression is upon us. Investors may see this as further confirmation that America is America no more, that America is now a socialist nation.
PERMANENT tax cuts seems like the best way to say we have faith in America as a free, free enterprise nation. But our profit and loss, success and failure system requires bankruptcies, defaults, and a reduction in profligate spending by states.
Environmental and other de-regulation is just as important. Scrap CAFE standards. Allow the building of new refineries. Ease the construction of new nuclear reactors. Make it clear that drilling in ANWR and offshore are business decisions to be made by businesses and by the affected states.
When America is friendly to business, business will be more friendly to America. I spent my life thinking one could not do better than to invest in America - to invest in the US stock market. Now I expect to sell on upticks for the remainder of my life.
Nam Vet
With real tax cuts and higher take-home pay, consumers can start planning for future purchases of big ticket items. Don't forget higher take-home pay also means more ability for loan qualifications even in today restrictive credit markets. The stuff I see coming out of Washington right now doesn't have a prayer of solving things. Nor am I encouraged when the Chairman of the House Ways and Means Committee (Rangel), who's in charge of tax policy, says he didn't realize he was breaking any tax laws with his apartments in NYC or the vacation home in the Caribbean. Good grief, he doesn't even know the law, but he's in charge of it! God help us all...
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.
He won't do it.
How much you want to bet that the Treasury’s gold (you know, the gold that hasn’t been audited since the 50s) is in the hands of this elite crowd?
The Japanese response exascerbated their problem, but it didn’t destroy Japan because they has HUGE savings and they had a healthy trade surplus.
We have neither.
But watch this unfold- as dollars lose the confidence of all who hold them, gold or other currencies becomes more trusted as a store of value. Let the control freaks have all the dollars they want then.
Talk about counterintuitive...
But also watch for a new fiat currency t emerge as the dollar is destroyed. The central banks must maintain their control over us somehow.
That sounds like the Zimbabwe national anthem
Nam Vet
For the life of me I can't understand how politicians are going to sell off the idea of a abandoning the secret ballot, but they have to since that's what was promised to organized labor for their Obama support. But, the GOP will just sit in the background with its thumb up its butt and get nailed to the wall again. Gutless wonders, all of them, and they wonder why we quit giving of our time and money.
Nam Vet
Will "Helicopter Ben" do the right thing? It doesn't seem like he knows what to do. Does anyone?
That chart is scary. Why is the trend such a downward slope - because we're being taxed to death?
I have been reading about Argentina and how it defaulted in 2001. The influential people were saved from the worst of it; the middle class was effectively wiped out; crime and famine soared; and the banks were still in business. Are we headed for the same fate?
That's a good idea.
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