Stripped of all the acronyms and economist-speak, government policy of the past few years has been simple: lower interest rates to push people out of cash (which yields nothing) and into stocks and houses. And then, when those assets go up enough to make their owners feel rich, hope that this paper wealth translates into a willingness to max out credit cards and take out car loans.
This propensity to borrow and spend more when your investments are rising is called the wealth effect, and by early 2013 it seemed to many that America’s “normal” debt-driven consumer society was reviving and that we might, after all, be able to maintain our military empire, welfare state, big houses, SUVs, massive banker year-end bonuses, easy incumbent reelections, etc, etc, without any prioritization or hard choices.
Nope. It turns out that the laws of economics can be bent but not broken. You can’t have a vibrant, growing economy AND interest rates near zero AND a stable currency at the same time. One of these has to give. And in the past month interest rates have started moving back towards historically normal levels.
Rising interest rates are incompatible with housing and equity bubbles, and the air is now leaking from both. As this is written on the morning of June 20, global stock markets are down big. And US housing, which in some markets was approaching 2007-esque levels of speculation, has hit a wall, at least based on mortgage applications:
Mortgage applications tumble as rates rise further: MBA
(Reuters) – Interest rates on home mortgages rose last week to hit their highest level in over a year, sapping demand from potential homeowners, data from an industry group showed on Wednesday.
Rates climbed 2 basis points to average 4.17 in the week ended June 14, according to the Mortgage Bankers Association. It was the highest level since March of last year.
After hovering around record lows, rates have surged for six weeks in a row, pushed higher by worries that the Federal Reserve could slow its stimulus program sooner than had been expected. Rates have accelerated by 58 basis points since the start of May.
The Fed’s bond purchases have kept borrowing rates, including mortgages, low. Though mortgage rates remain low by historical standards, the ultra-cheap mortgages have helped lure buyers back into the market and worries have crept in that higher rates could disrupt the still-young housing recovery.
The rise in rates appeared to hold back homebuyers as MBA’s seasonally adjusted index of loan requests for home purchases – a leading indicator of home sales – fell 3 percent. The gauge of refinancing applications slipped 3.4 percent, though the refinance share of total mortgage activity held steady at 69 percent of applications. The overall index of mortgage application activity, which includes both refinancing and home purchase demand, declined 3.3 percent.
And so the wealth effect shifts into reverse. Fewer people can afford mortgages, so home prices stop rising, making homeowners feel less rich. Stock prices stop rising (or, like today, start going down) and the record number of people who have been buying on margin see their exciting gains melt away. They feel both less rich and suddenly very stupid. Most of them will spend less, and the recovery will stop in its tracks.
Which means it’s time to think about the next big government plan to save us. Will it be a massive public works program? Expanded QE? Maybe a major war? Whatever, it will have to be commensurate with the size of the now-global crisis. So, just a guess, but this time around it won’t be surprising to see a coordinated attack on deflation from Europe, the US and China. In other words, global Abenomics.
Abenomics, two thoughts:
1. It isn’t working in Japan.
2. It only works if everyone believes that central banksters can fix the problem. When folks lose faith in central banksters it won’t work. More and more are starting to think that central banksters are the problem.
We’ll find out soon enough I suppose, 10Y Treasury rates are at 2.425% as I type.
Bill
Abenomics doesn’t work and won’t work. It proves you don’t understand what happens in Japan. So, worldwide Abenomics will fail as well. Higher interest rates ? I wouldn’t be surprised to see rates (T-bonds) to go lower in the next weeks to, say 1%. And that’s what a lot of folks don’t like.
Duh. That’s kind of what I was saying. There comes a point when we owe so much that there’s no fix. Yet they keep trying.
Duh. That’s what I was saying. There comes a point when you owe so much money that there’s no way to fix things. Yet governments keep trying.
Abenomics did work but it didn’t help the japanese consumer. As a result of a lower yen import prices have gone up and japanese had to spend more money for e.g. gasoline, groceries. And that pushes GDP higher. But those higher prices come out of the hide of consumers.
Central banks aren’t able to combat deflation. It didn’t work in 1873, 1929 & 2008 and won’t work in 2013. And my favourite indicator showed a negative divergence with the S&P 500 since november 2012.
The question isn’t whether massive debt monetization can “work” or not, it obviously hasn’t and won’t. The question is what form the failure takes. Will we fall into a 1930-style deflationary depression or will the dollar, yen, and euro lose the confidence of the markets and fall off the table? The latter seems more likely since that’s the only thing that will stop the monetization process.
I see. In other words: (Hyper-)Inflation or Deflation ?
My reply: IF I was forced to make a bet then I would put all my money on Deflation (without a shadow of doubt).
Deflation destroys credit/debt, NOT (fiat) money (Euros, Yen, USD). Currencies may become worth LESS but they are NOT going to be worthless in deflation)
Hyper-Inflation destroys both credit/debt AND (fiat) money. Hence the flight into tangibles/commodities. (Do we see commodity prices, gold go through the roof today ?)
“Hyper-Inflation requires Hyper-Deflation” (=Collapse of the bond market)
“Hyper-Inflation is a political choice”.
Source: Hugh Hendry & Robert Prechter.
Central banks can in the current situation literally print LOTS of new money/banknotes but it won’t lead to Hyper-Inflation, anytime soon. Because citizens will use those newly printed banknotes to pay down their debt (=destruction of debt+credit = deflation). Only when A LOT OF debt has been destroyed, Hyper-Inflation has a CHANCE of succeeding.
Zimbabwe, Weimar Germany & Serbia (1990s) chose to Hyper-Inflate. The FED in the early 1930s chose to NOT Hyper-Inflate. It revalued gold against the USD, in order to revalue the US goldreserves and re-establish confidence. To do so, the gov’t also had to control the circulation of gold. Hence the confiscation in early 1933.
No. Monetization by the FED will stop when it’s clear that e.g US taxrevenues are collapsing/dwindling. Because it’s the US gov’t that still has to pay interest & principal to the FED on that monetized debt (e.g. T-bonds) coming out of the taxrevenues. The US gov’t can default on Freddie MaC & Fannie Mae debt. But it can’t default on its own debt. Because T-bonds are the reserves of the FED. Then the rest of the world will start to question the FED & the US banking system, the USD and above all the US gov’t.
The USD is the world’s reserve currency, yes. As a result of that t-bonds constitute the bulk of reserves of other central banks. So, if the T-bond market collapses then it WILL take down the rest of the world’s financial system as well. That’s why the FED simply WILL NOT Hyper-Inflate in the forseeable future. By doing so, the US would simply shoot itself in the foot, commit suicide.
Remember, the FED has also a mandate to defend the currency and that will supersede all other actions.
And the story above could be the reason why Bernanke has been using the word “Tapering”. It’s possible that he has seen US tax revenues are going through the floor. And that could be only one of MANY worrysome current developments. (Why do you think Obama has effectively fired Bernanke ? Did you see the story “Business Insider” brought ?) It’s already war in Washington D.C., IMO.
Why do you think “citizens will use newly printed notes to pay down their debt”? Do you think that if every US citizen received a check for $10,000 from the Fed (or a stack of 100 $100 bills) that they would pay down their mortgage or credit cards? Maybe they would but I don’t know of any evidence that suggests that, especially if they receive cash. In fact, I would submit that most would either consume something with it or save/invest it, and the more you give them the more they’ll save or invest it (although paying off debt can be considered a risk-free way of “earning” interest on the pay down amount.)
Also, you say that “the FED in the early 30’s chose to NOT Hyper-Inflate,” which I assume you mean to overly monetize. Ironically, Bernanke is “hyper” sensitive to ending monetization too soon this time, thus committing a fatal “error” like the 30’s Fed did.
By the way, the US Treasury is refunded all of its interest payments to the Fed each year so Fed monetizations are actually zero-interest loans to the US Treasury. Furthermore, the Treasury can absolutely default on its bonds, and stiff the Fed if it wanted to. So what if they are reserves of the Fed? The Fed prints its own money. It’s all about power, which is all about controlling the support of others, not money per se. So it’s the other way around, the rest of the world would actually respect the US gov. most of all if it grew a pair and dissolved the Fed completely. The Constitution forbids it.
Lastly, I agree that hyper inflation is a social phenomenon but you sound like a central banker yourself in thinking that they can control what people think about their money and their monetary system.
No. There’s a material difference between literally printing money(=banknotes for the general public) and monetizing debt (=creating credit/debt for banks). But in both cases the balance sheet of the FED grows. In the early 1930s the FED chose to not Hyper-Inflate (=literally printing banknotes). It was a political choice. Weimar Germany stopped Hyper-Inflation in november 1923 dead in its tracks. How ? They literally stopped printing new banknotes and the Hyper-Inflation was over within a week.
No, I never said that a central banker can control what people think and do with their money. If the people (“Mr. Market”) won’t cooperate then a central bank is powerless like in 2008. Then “Mr. Market” forces its will upon the central bank & government. In the 1930s market forces overwhelmed the actions of the FED.
You can parse the “material” difference between literally printing bank notes and creating binary numbers on a computer server all you want, but they fundamentally are the same thing because the two are interchangeable (one can always request cash instead of a check, say, from a bank, or digital entries on a server for cash.)
Consider, for example, how debt monetization of US government spending works. The US Treasury needs/spends about $80 billion dollars a month more than it receives in revenue, so it sells Treasury bonds to any sucker who’ll buy them to get the money. Ordinarily, when a normal investor buys a T bond the money already exists and is given to the Treasury in exchange for the bond’s contract (to get it back some time in the future at some rate of interest.) So far, so good- no new money has been created, it just changed hands. However, when the Fed buys the T-bond the money it gives the Treasury IS created literally out of nothing. It’s simply tracked via the Fed’s balance sheet as both an asset (the bond it now holds) and a liability (the “money” that theTreasury was given). The Treasury then spends that money, say, as unemployment compensation payments or food stamps or Section 8 housing, etc., and so it enters the economy and circulates, (and believe me mostly as cash.) The Fed “expects” to get that money back, but what it really cares about is maintaining control. The Fed has a claim on the money that it lent to the Treasury/US taxpayers, and so it has effectively invested in a form of control, as long as we the borrowers respect and honor that bargain. So, as far as everyone except the Treasury is concerned, more money has literally been added to the system and it is price inflationary for the simple reason that ordinary supply and demand is shifted towards higher prices because there is more demand (money available to spend) for the same supply.
Now, if you mean that “printing” money and giving it to individuals (or their creditors) directly and freely – meaning there is no (bond) obligation to repay that “loan”, then I fail to see how that increases the Fed’s balance sheet. In fact, I think that would have been the wiser course to have taken. Kill the debts and start the game over. As it is now, there is more money in circulation and more debt to go with it, and now the central banks have compromised their positions.
So here we are.
What you’re missing is that a banknote is credit as well. It’s considered to be a loan from the public to the FED/gov’t. But the public nearly never calls in those loans. So, when the gov’t/FED starts printing banknotes then the FED’s balance sheet increases as well.
The difference between monetizing debt and printing banknotes to finance the gov’t’s expenses is that with printing banknotes the FED circumvents the (commercial) banks.
Monetizing debts increases the credit (a.k.a. excess reserves) to banks. And banks will use that money to bid up the last “hot game in town”. But that requires that – at least – one asset class goes up in value.
The reserves of the FED consists of gold & T-bonds. So when/if those T-bonds loose value then the reserves of the entire banking system shrink in value as well. That’s why a gov’t defaulting on its debts is so devastating for the banking system.
You also have to take into account that there was a giant bull market in T-bonds. Interest rates went from over 15% in 1981 to ~ 1.4% in mid 2012. A LOT OF deflationistas (wrongfully) see that as deflation. It’s NOT. Because T-bond prices have gone higher & higher since 1981 (=asset INFLATION). That’s why Rising rates are actually DEFLATIONARY (=asset deflation).
So, the INFLATION has been since 1981 in stocks, bonds, real estate. Since too many entities can’t service their debts, Deflation is the only possibility.
Mr. Bernanke made it clear during his speech what his intentions were. The only number that is going to move him is the unemployment number. Housing data certainly as well, but it is the unemployment number that he is tied to and which remains the key metric by which further money printing can be justified. At this juncture, he is simply waiting to play the next hand. Why play the hand now when the formula for $stimulus has worked for the past 5 years running? And why go out on a sour note, when you hold the cards to go out with a cheering section lauding you as the savior of the economy? All he has to do is wait it out.
If the U.S. economy really has (self-powered) legs, we’ll know by September – or perhaps even sooner. If it does, the $tapering tape-worm will no longer appear the frightful specter. If it doesn’t, Bernanke will be there. It would wise also to remember that we are approaching a mid-term election year with an incumbent president, heading into the lame-duck season of his post. Dropping the ball on the economy, and consequently sentencing the Democrat party to 6 years in the wilderness, is not what this President or Senate has in mind.
i liked your interview john. im getting sick of waiting and predict precise moments. i think im just going to bail soon.
only one thing will stop the econimplosion…nationaizing the fed ..stopping the debt
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