Gold up $10. The Dow up 40 points. The S&P pushing into record territory.
Yesterday, we revealed Richard Duncan’s outlook for the months ahead. You noticed, surely, that it corresponds with our own, at least to an important point.
The key insight is that the economy has come to depend on huge buckets of ‘liquidity’ from the Fed. (We put “liquidity” in quotations, because it is not clear how fluid this quantitative easing (QE) really is). As long as the quantity of this liquidity exceeds the economy’s uses for it (principally borrowing by the federal government and corporations) stocks have a tendency to go up. When it goes down, stocks tend to go down too.
Duncan anticipates that liquidity will turn negative in the last quarter of this year (with less available cash and credit than the economy needs). If they haven’t sunk already, stocks will go down to where they belong.
But the Fed seems to have taken a blood oath to keep the credit bubble expanding to the end of time, or until it blows up, whichever comes first. Janet Yellen has recently revealed herself to be a remarkable personage for a central banker. (She is, after all, a disciple of the infamous Yuri Pavlovovich!) She will not stop or sidestep the trap; she will walk right into it, recklessly blundering into the biggest financial disaster of all time.
Ah yes, you might as well know. There’s more to Mr Duncan’s macro views; a lot more. In 1964 – half a century ago—the US had a total of $1trn worth of credit. Today, the figure is $59trn. Did the size of the economy also grow 59 times? Is our bigger, more prosperous economy now able to support $59trn worth of debt, or more?
In 1964, the US GDP was $656bn. Let’s see, today it is around $17trn. Divide $17trn by $656bn and we find that GDP has gone up 26 times, not even half as much as the debt.
Each unit of today’s output supports more than twice as much debt as it did 50 years ago. Or, to put it another way, twice as much of what you see today – cars, hamburgers, houses, big-screen TVs – owes its existence to transactions that have been completed. There is a day of reckoning for every credit purchase; the coming settlement will be extremely painful.
Normally and naturally, the amount of credit in the world is controlled by the amount of savings. You can’t lend someone something you don’t have. And if you don’t save money, you can’t lend it to someone else.
But fractional reserve banking, a reduction in required reserves, and a shift to an elastic currency (in 1968) made it possible to create credit ex nihilo. Out of nothing.
Bill Bonner on markets, economics & the madness of crowds
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We know that ex nihilo, nihil fit. But the whole modern world economy depends on it anyway. So, if credit growth had just kept up with GDP growth, it would now measure about $26trn, not $59trn. The difference would have to disappear. Ex nihilo it came. Ad nihilo it will go. That is, $33trn worth of spending and asset prices would go ‘poof’.
And that is what you should expect when the credit bubble pops. The Great Depression saw output cut by more than 40%. The next great depression should see an even bigger drop. Unemployment reached 25% in the Great Depression; the next depression should be worse. In the Great Depression, a large percentage of the US population was still semi-self-sufficient, with gardens, chickens, hogs and extensive home preserves. Today, few people could support themselves even for a few days.
Central banks have created a hideous monster. Now, it will devour their own children – banks will go bust, asset prices will collapse, globalisation will go into reverse.
As the Austrian economists warned us: any credit in excess of actual savings is a fraud. It produces a fraudulent boom which must be followed by a bust. Eventually, the phony credit must go back whence it came. Central banks can delay it. They can’t avoid it.
Today, the whole world relies on this never-ending credit expansion in the US. Without it, China’s economy would collapse along with the US. The US stock market will be chopped in half – at least. In short, it will be one goddawful mess.
Richard Duncan, however, goes further. A credit deflation – which may or may not be imminent – would also knock the wind out of government finances, he says. Social security, education, welfare programs, military spending – all would be substantially impaired as $33 trillion worth of excess credit goes away.
“In all probability”, says Duncan, “our civilisation would not survive it”. Instead, he believes a credit deflation will bring “chaos, starvation and war”. Are you ready for this, dear reader?
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