Robert Prechter writes (emphasis added):

Economists hint at the Fed’s occasional impotence in fostering credit expansion when they describe an ineffective monetary strategy, i.e., a drop in the Fed’s target rates that does not stimulate borrowing, as “pushing on a string.” At such times, low Fed-influenced rates cannot overcome creditors’ disinclination to lend and/or customers’ unwillingness or inability to borrow.

We would add some thoughts to this simple concept.  Prechter has emphasized credit expansion, but there is more to it than that. First, there is a difference between customers who are unwilling to borrow and those unable to borrow. Those unwilling to borrow are also likely unwilling to spend.  While those unable to borrow are likely to have few assets to sell to feed their desire to spend.   So… suppose the government bought all bonds, public and private, for (newly created) cash.  Those who would spend but who had no assets to sell would receive no new cash and would not spend more.  Those who had assets to sell will have received new cash in return for their bonds, but they didn’t want to spend in the first place.  Any one or more of those  individuals could have converted their close-to-zero yielding bond assets to cash and spent at any time, but chose not to.  Will one who is unwilling to borrow and spend suddenly become more inclined to spend and thus make prices rise, simply because the makeup of his portfolio was changed – against his will- from close-to-zero yielding bonds to absolutely zero yielding bonds?  The answer is unclear, particularly, if he expects prices to fall.  The FED might want to take a survey of these folks…

You don’t have to be a bank to inflate or deflate.

Jimmy Songwriter sitting at the bar has a flash of inspiration and quickly writes down a new song.  His somewhat inebriated friend, Joey Songsinger hears the song once and enthusiastically offers to buy it for a price equal to “whatever it takes – even if it’s the whole income of the United States”.   Jimmy Songwriter, as a joke and to teach his friend a lesson, tells Joey he will sell the song for $13 Trillion and that he would finance it and Joey signs a note to Jimmy for $13 Trillion.  This single transaction goes on record as the highest price ever paid for a song… drives up the average price of all songs by a factor of thousands…and doubles nominal GDP  and the average price of all goods and services in the United States.  The next year at Christmas, when the note comes due, Jimmy sends his friend Joey an email offering to “settle” the note for $500.  Joey gladly agrees.  After all they both knew that’s what the song was truly worth …and what Joey could pay.  That year, nominal GDP falls from the previously inflated level by roughly 50% with a 50% deflation in the price level as there are no more songs sold (and financed) for such exorbitant prices.


1. We didn’t need banks or the Federal Reserve to create the price inflation or the price deflation which followed.  All we needed was debt creation and then the subsequent de-leveraging and return to “normalcy”.

2. Neither Jimmy nor Joey had the legal power to “print” or coin “money” and they did not need it to affect the price level.

3. Most importantly, what Jimmy and Joey do can offset and overwhelm whatever the Federal Reserve and the banks do.

Washington’s blog is encouraging debate on what monetary system we should have in the United States.  In the discussion, Australian economist Steve Keen advocates that equity shares owned by the original owner when the physical underlying capital was formed would have perpetual life.  However, once the original owner sells the shares in the secondary market, the share begins to expire over (say) 25 years.  Dr. Keen points out the benefit of this arrangement:

Shares purchased in an initial public offering or float would last indefinitely while held by the original purchaser. But once these shares were sold, they would have a defined life of (say) 25 years.

This would have several benefits over our current system:

(1) Purchasers of shares on the secondary market would be forced to do what the Capital Assets Pricing Model (the delusional neoclassical theory that dominated academic finance prior to the GFC) pretended they do now: to value shares on a sensible valuation of expected future dividend earnings. You would only buy a share under this system if you expected a reasonably good stream of dividends from it, because in 25 years it would expire; and

(2) It would encourage the act of providing finance to new ventures. At present, the share market does a very poor job of providing new finance, with over 99% of the transactions being secondary market sales in search of capital gains. With my change, the only way to secure an indefinite stream of revenue from a new venture would be to provide it with some of its initial capital. This proposal would drastically shift the balance in favour of raising initial capital, which is the only truly socially beneficial role of the stock market.

We applaud this sort of thinking…good luck in getting it past Goldman Sachs.

However Dr. Keen has an even more valuable piece that strongly supports the arguement of the “deflation camp”:

So the following numerical example might make it easier to understand their arguments:

  • Imagine a country with a nominal GDP of $1,000 billion, which is growing at 10% per annum (real output is growing at 4% p.a. and inflation is 6% p.a.);
  • It also has an aggregate private debt level of $1,250 billion which is growing at 20% p.a., so that private debt increases by $250 billion that year;
  • Ignoring for the moment the contribution from government deficit spending, total spending in that economy for that year–on all markets, both commodities and assets–is therefore $1,250 billion. 80% of this is financed by incomes (GDP) and 20% is financed by increased debt;
  • One year later, the GDP has grown by 10% to $1,100 billion;
  • Now imagine that debt stabilises at $1,500 billion, so that the change in debt that year is zero;
  • Then total spending in the economy is $1,100 billion, consisting of $1.1 trillion of income-financed spending and no debt-financed spending;
  • This is $150 billion less than the previous year;
  • Stabilisation of debt levels thus causes a 12% fall in nominal aggregate demand.

With the fall in demand, we can expect falling prices.  Consider: unless the government is able to create debt in amounts sufficient to offset more than the current decline in private debt (virtually impossible in the current political environment), we will see continued declines in GDP and…deflation.

John Mauldin is in the “mild” inflation camp, while Bill Bonner is in the deflation camp.  Mauldin cites the elements resulting in a tendency toward deflation as rising unemployment, massive wealth destruction, decreased final demand, low capacity utilization, massive deleveraging and a very weak housing market. But, then he bravely argues that our powerful, benevolent Federal Reserve will allow neither Bonner’s deflation scenario…nor large rates of inflation as posited by Peter Schiff:

The Fed is going to do what it takes to bring about inflation (in my opinion). But they will not monetize US government debt beyond what they have already agreed to. If they need to “print money” to fight deflation, they can buy mortgage or credit-card or other forms of private debt, which have the convenience of being self-liquidating. Read the speeches of the Fed presidents and governors. I can’t imagine these people will recklessly monetize US debt. You don’t get to their level without having a stiff backbone.

Mauldin’s apparent  blind faith in an effective, competent, and non-captured FED seems out of character.  It’s probably not naivete’ , but whatever else it is, it’s dangerous advice to bet on a potent FED in these times.  For our own part, the elements supporting deflation, as listed by Mauldin, are outside the FED’s control.  If they were within the FED’s control the FED would never have allowed them to begin in the first place.

So…since inflation benefits the people who owe lots of money and hurts people who are savers…guess who the economists want to benefit?  That’s right!- we figured you’d get it.  According to Bloomberg, since May, economists have been calling for inflation to trick people into spending/consuming rather than saving and to “lessen” the burden of the “debt bomb”.  Funny thing, the debt is owed to someone and it’s those people who are owed that suffer when they are paid back with devalued dollars.  So who is the group that benefits most directly from inflation?  You might think people who owe home mortgages.  But, since they are NOT seeing any wage inflation, they’re not benefiting…  It’s the banks- they are levered to the hilt and they get to pay back their debtholders with newly printed money.  Recently, a long list was published of economists who advocated “independence” of the Federal Reserve – independence meaning freedom from Congressional oversight. We suppose all economists aspire to work for the Federal Reserve and that’s why they all protect the FED at the expense of savers.  But even though the FED may be free from Congressional oversight, the FED is never free from its legal owners – the very same levered banks who benefit most from inflation.  IStockAnalyst has a good piece on this here.

Nathan’s Economic Edge has a pretty good capture of where we are presently. Check it out. (ht TPC)

…a pretty clear picture to me, one of DEFLATION at work. It is accelerating, not decelerating. That is a HUGE divergence from what’s occurring in the equity markets and from what you hear on television from the supposed experts.

I think we are on the precipice of a self-reinforcing deflationary spiral. The data is historic. The disconnect between the data and perception is historic. The Fed is attempting to do a magic trick by printing their way out of debt – it’s a trick that has NEVER worked throughout the history of mankind and will not work to create real growth now.

Debt is the ball, keep your eye on it and you’ll see through the Fed’s attempted magic trick and slight of hand!

While the money supply measured by viewing banks reserves or even deposits is increasing, total debt is collapsing.  The government’s valiant effort to offset declining private debt with massive government borrowing is not working.

Karl Denninger at Market Ticker, based on his on assessment, is hitting 13 of 25 economic predictions he made for 2009, with half a year to go for more of his predictions to come true.  Since he’s shooting pretty good…what else is he predicting?  It gets pretty gloomy:

At some point reality must be faced, and we may as well do it now while we still have civil order.  Those politicians, numbering nearly all of them from both parties, who argue that this can be “avoided” or that we can “support housing (and/or asset) prices” need to be run out of town on a rail.

There is no way to prevent the unwinding of leverage when the carrying costs exceed income and the more debt we as a society take on in trying to do so the worse things will get in the end, as we are simply adding to the pile of defaults that must occur.

I am quickly running out of possible scenarios to prevent a severe deflationary depression from taking place.  By “severe” I mean 20%+ U3 unemployment, GDP contraction of at least 25%, and a possible loss of federal funding capacity leading to the immediate destruction of Medicare, Medicaid and Social Security, a 50% reduction of defense spending and near-complete-elimination of all other Federal Programs due to a “sudden stop” in the ability to fund Treasury issuance.  Yes, it could get that bad, and it could happen a lot faster than you think.

I wish there was good news – “green shoots” – that I could honestly find and report.  There are not.  There is only more obfuscation and fraud, which I have and will continue to chronicle here in The Ticker, not so much in the belief that government gives a damn, but rather so that historians have it available later and, if the collapse I believe is possible does materialize, the angry proletariat with pitchfork and torch will know where to properly direct their wrath.

Government needs to lock up the psychopaths that have run the asylum for the last 20 years and let adults into the room to rationally discuss the inevitable and how to best deal with it.  They’re refusing now, just as they did when Bush was President.  This is not a partisan debate – even having lost badly in November the Republicans are wasting time with the same old canards about “Tax and Spend” instead of attacking the problem at the root: fraudulent credit issuance, much of which they championed and enabled themselves.

Swamp Report agrees that the government is a big cause of our problem and an even bigger reason why it’s getting worse.  The current despotic government needs major overhaul before many more of Karl Denninger’s predictions come true…

The BLS released its PPI for May.  Not a big market mover.  However, it’s intriguing to Swamp Report that were it not for the orchestrated rise in oil prices, the PPI would have shown a significant decline

From FP Comment:

“One test of whether we are witnessing the end of America is how many more times Americans put up with congressional show trials of individual business people and their employees, slandering and vilifying them for their actions and motives. And for how long will they tolerate a President who berates business and corporations as dens of crime and malfeasance?  If the majority of Americans come to accept the caricatures of business as true, then America is closer to the end of its life as a global leader, as a champion of markets and individualism.”

“…the Fed will have to be prepared to absorb all the excess money it has poured into the U.S. economy. It will be a technical and political challenge unlike any central bank has ever undertaken. The future of America is at stake.”

We at think the odds of successful removal of those reserves once loaned out is a very long shot indeed.