Quantitative Easing is celebrated as the secret weapon of economic
salvation in the arsenal of central banks that their unfortunate and
less-enlightened predecessors did not possess. Thus the long duration of the
Great Recession of 1929. Or at least, that’s the revised history.
In reality, the massive deflationary event now known as the Financial
Crisis of 2008 was the result of a buildup in liquidity caused by low
interest rates and incrementally easier lending terms. The global liquidity
pool itself was further inflated by creative accounting techniques like
multi-leveraging, where Tier 1 capital and other solid assets were pledged
multiple times from various lenders.
The application of that liquidity to the housing market fuelled an asset
price bubble, and when panic resulted from a collective realization that a
Wyle E. Coyote moment was about to ensue, the domino effect began, taking
down Bear Stearns, Lehman Brother, and almost, if it weren’t for a quick
nationalization of AIG by the Fed masquerading as an $85 billion loan, one of
the world’s largest insurers of financial instruments. The contagion would
have continued to engulf banks and insurers alike as default triggered
default, and liquidity froze out everyone out of fear of counterparty balance
sheet fraud.
With the public in shock over the sudden reversal of fortunes – especially
after a half-decade’s worth of muscular year-on-year growth that had
accelerated the economy out of the dot com debacle -the newly elected Barack
Obama flexed his freshly pumped presidential muscle, and unleashed successive
rounds of Stimulus – or Quantitative Easing as it was subsequently re-branded
– totalling $4.5 trillion in new liquidity before the effects of fractional
banking expand that by 4 – 12 times.
Regardless of the decorous and technical language that now varnishes and
anoints Quantitative Easing, it remains nothing more or less than the
creation of money out of thin air. This will require bearing in mind as we
contemplate the future of a thus artificially stimulated global financial
system.
However, in the meantime, Interbank lending has normalized, the stock
market is in bull mode, employment data has been massaged into an apparent
increase, and the recovery was/is complete/underway.
Except for….one tiny little widely glossed over detail that at this point
constitutes an Inconvenient Truth.
The fundamental cause of the crisis – excessive liquidity and rampant
lending – is still present. In fact, it is present in an exponentially
greater iteration of its former self. What stock market performance and
electro-plated employment numbers fail to convey is the absence of
fundamental demand for real goods.
The excess liquidity now supercharges synthetic asset classes derived from
real commodities, and in a fascinating case of utter delusion, the derivative
asset classes have become the largest consumers of the fabricated capital and
credit.
This is fundamentally why price inflation has remained largely absent –
the world’s largest capital pools have grown so big that dealing in the
markets of real goods is just too puny a pond to be attractive to these
whales.
Thus, the bulk of the fabricated liquidity multiplies and moves in a layer
of the financial food chain largely separate from the real world.
GDP: The False Positive
Quantitative Easing created marginal GDP acceleration, and this is proof
of a return to growth based on fundamental economic demand, claim the
economists.
But that argument is looking progressively um…lets use the word
‘disingenuous’ to avoid any appearance of impropriety. A less discrete
characterization would probably fall along the lines of ‘like complete
bullshit’.
Stepping backward and upward to the 50,000 foot view, the economic mantra
of ‘growth at all costs’ has become increasingly difficult to obtain, as
developed countries have three and four of everything, and undeveloped ones,
though they would like to imitate their northern counterparts and have three
and four of everything and a bottle of chablis in the fridge and meat for
dinner instead of beans and rice, simply have too many people trying to
squeeze that lifestyle out of too few resources.
At the top end of the economic food chain, nobody but nobody is paying
anywhere near a proportionally appropriate income tax relative to their
lifestyles. Of course, if you were to suggest that over polite and
well-heeled conversation at Le Bernardin, you would find yourself ostracized
by high society and branded a communist.
The North American and European standard of living has been developed over
centuries on the resources of what we politely term ‘developing countries’,
and so that term becomes a contradiction in terms, as the plum assets have
already been plucked and shipped north.
And so, here in 2015, we are stuck clinging to the illusion that the economic
thrum of the 2000’s is just around the corner.
Unfortunately, such is not the case. What we have around the corner, and
what is already, in reality, well underway, is the global deflationary
response to the collective realization that the planet is maxed out in terms
of what it can provide for its number one consumer species – humanity. In
fact, if you consider the scope, scale and duration of the deflationary event
of 2008 that preceded ‘the worst financial crisis since the Great
Depression’, when the benchmark of global liquidity – the U.S. Federal
Reserve’s balance sheet – was a mere $800 million, just imagine what that
scope scale and duration will look like magnified by 5.5.
Just like the precursor to a massive tidal wave is an abnormally low tide
presaging the advent of an outsized wave, the outflow of capital from oil,
metals, commodities (and soon real estate) is underway now. It is in fact,
the first stage of the next major deflationary event and recession. Which
this time, if I were to be a claimant on the mantle of Oracle, I predict will
result in the Greatest Depression ever.
Economy is Ultimately Subject to Physical Laws
If we accept the economy as an essentially biological ecosystem that is
subject to the largely self-moderating nature of healthy ecosystems, this
makes sense.
I would argue that Quantitative Easing –
or more accurately, an excess of liquidity – is the cause of deflation. I
will further argue here that spreading deflation is the precursor to not just
inflation, but hyper-inflation. Furthermore, this whole deflationary phase
that has defined the global economy since 2008 is the outcome of excessive
liquidity in the system in the first place.
In rough terms, the real estate bubble
in U.S. grew to the size it did because interest rates were low and banks
were lending to ever less qualified borrowers in pursuit of expanded income
at any cost. Since then, the deflationary wound-licking that has gone on has
been offset by the Fed’s wishful thinking that replacing the since absent liquidity
with synthetic liquidity of its own will somehow purchase fundamental demand.
All it has purchased is bigger capital pools for the elite, and record equity
market highs. The only stimulating effect on the broader economy is when the
elites need their pools cleaned and their grass cut; not the sort of demand
that is going to rekindle the American Dream
Consider the nature of the financial
system in its now nearly totally globalized system of transmission and trade.
Money can go anywhere electronically, at the press of a keystroke, and in
fact, 98%+ of fabricated liquidity (my term for Quantitative Easing) exists
and moves through the system in electronic form, converting into different
currencies automatically.
There are two aspects to each of
inflation and deflation that differ yet accompany one another, usually with
some latency in time.
At its most elemental, monetary
inflation occurs when central banks create money in excess of what is
required for use by the trade in the economy. Price inflation occurs when an
excess of capital chases goods for inventory purposes, just as a way to
deploy some of the excess capital accrued through monetary inflation. The
reverse, in both cases, roughly defines deflation.
When the excess of fabricated capital
and credit reaches the point where no more capital can be deployed to acquire
inventories because inventory is at capacity, the capital ceases to be
accessed, and capital velocity – the rate at which money flows through the
financial system – grinds to a standstill.
At that point, money can only park
itself in fixed income and derivative strategies where risk is minimized in
line with capital preservation objectives. It becomes ‘stagflation’. No
economic growth. No price inflation. No investment in the real economy.
After a period of stagflation, monetary
deflation – the precursor to economic stagflation – begins to foster price
deflation. The prices of goods begin to go down, as competition for
diminished dollars causes manufacturers to blow out inventories just to stay
afloat. When that general tend solidifies, the available purchasers of goods
begin to defer spending, accurately speculating that future prices are going
to go down further, thus reinforcing monetary deflation, a reduction in
capital velocity, and ultimately, recession followed by depression.
We are currently at the point where
monetary deflation has begun to induce price deflation. And several
fundamental changes have now occurred on the macro-economic landscape that
are converging to reassert the physical laws of the universe by which we are
all governed.
The End of the Business Cycle
Students of modern history take solace in the belief that the cyclicality
of business is a cornerstone of economic reality. Unfortunately for them,
such is the case only when certain aspects of the mechanics of global finance
are consistent. For example, the supply of money has, until the last five
years, always borne some semblance to what was required by the daily movement
of goods and services throughout the economy. So that is the first
fundamental shift that has undermined the cyclicality of business.
Secondly, the willingness and ability to regulate the world’s largest
financial pools has deteriorated to the point where it is more accurate to
state that regulators are governed by the interests of the world’s largest
capital pools. That is the second major fundamental shift from the 20th
century that will result in the end of all traditional business cycles.
The result of these two major tectonic shifts is that traditional
investment is ending, and for the most part, only trading remains. The idea
that a capital resource is willing to deploy capital for equity or interest
in a given enterprise, and wait 3 – 5 years for that value to be amplified
and returned to the investor through the output of the enterprise, grows
increasingly scarce. Who wants to put a billion dollars at risk for 2 -3
years to build a mine when you can deploy such a sum algorithmically for a
day or a week or a month and realize an admittedly more conservative return,
but with a fraction of the risk. The capital can be deployed again and again
in the world of synthetic derivatives, ETFs and as short term tranches of
high yield corporate debt, making such trading far more attractive than
traditional investing.
This capital and credit black hole did not previously exist on such a
scale, and so previous buildups of excess liquidity in the system resulted in
price inflation, as the only place for that money to go was into real
commodities and their (then) real derivatives. (Real derivatives versus
synthetic derivatives are differentiated by real ones actually resulting in a
quanitity of the underlying asset being delivered, whereas in the modern age
of synthetic derivatives, futures contracts are never reconciled to actual
inventory, and credit default swaps are synthesized to bet on the outcome of
bets on other synthetic products).
This may sound like simplistic thinking, but it is important to bear in
mind that all things economic and financial are still governed ultimately by
the physical limitations of real supply and real demand. Thus economics, at
the end of the day, is always simple – technical mathematical quant
mumbo-jumbo notwithstanding.
Thus, our infrastructure crumbles, pensions go unfunded, manufacturing is
extirpated, and the economy striates into hugely imbalanced classes.The
decline of civilization is underway, though if you’re a member of the
uppermost percent, you will find such an idea ridiculous because you are so
insulated from reality that you won’t be able to see what’s going on outside
of your Faberegé egg existence.
When the system breaks, as is inevitable, it is those with vast
accumulated wealth who will become the targets of the tremendously more
impoverished and desperate. Financially, you cannot ‘protect’ yourself from
the inevitable.
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