Don’t worry about the Fed printing…yet.

Here are a couple of charts that illustrate the significance of what the Fed has undertaken lately. First, look at the change in its balance sheet this year from about $870 billion, almost all in Treasuries, to $1.5 trillion, with fewer Treasuries, more repos and swaps, and an alphabet soup of new credit facilities:

Source: Federal Reserve Bank of Atlanta’s Macroblog (yes, a Fed branch has a blog).

For the inflation/deflation issue, what matters at the moment is that all that new credit (not much new currency, only about $30 billion more in actual notes) is just sitting in banks. Unlike in the Greenspan years, nobody worthy of credit wants to borrow the new funds, since they can’t generate positive returns on investments, and the banks aren’t lending to people with bad credit anymore.

How do we know it is not being lent out? The Fed is actually pretty transparent as far as nefarious government sponsored entities go, and provides a lot of useful data through the FRED website. Here is the sum of loans and investments at US commercial banks:

–

As you can see, lending has gone flat after an enormous expansion. And this is just the past 5 years — check out the longer view for a graph that would have knocked Mises’ Austrian socks off:

When you hear “credit bubble”, think of the above.

—

Workers of America, Unite! (to fight the evil of lower prices)

Inflation, in the end, will have to come from massive government spending programs. The Greater Depression will have a scaled up New Deal. Keynesianism is still all the rage, and when the bailouts have had time to fail, expect Obama to start handing out trillions to government contractors through various new Orwellian-sounding departments and administrations.

For the dollar, the Treasury market will be the canary in the coal mine. It is rallying now from safe-haven buying, as it should, and it could even go a lot higher, but when it turns, grab your gold and run. Nothing is so damaging to an economy as government work programs and the kind of inflation that they create. This is what happened in the Wiemar Republic. The government was the main employer, and it paid workers (and foreign creditors) with freshly printed cash.

In the US, I imagine that the public finance system will continue to operate as it always has: 1) Taxes, income from which will continue to drop in the depression; 2) Bond sales, but there is a limit to the world’s appetite for notes from a bankrupt creditor; 3) Federal Reserve money creation for the purchase of bonds that the public does not want. This last part is how fresh cash gets into circulation, and how the government indirectly funds itself through printing. When public demand for Treasuries dries up, you can bet the government’s demand for funds will be greater than ever, so then we will see what Bernanke can really do with a printing press.

Why bailouts will not stop the depression

The market is a force of nature, like gravity. To use it is prosperity. To fight it is misery.

—-

By bankers, for bankers.

This is a bailout of bankers. The Fed was created by bankers, and the Treasury is run by a banker, so there are no surprises here.

The plan is to have the government take banks’ bad mortgage debt (will they add credit card, auto, student and corporate debt?), so that they are no longer insolvent. Solvency has always been the issue, not liquidity — that is a red herring. By no means will all of the bad debt (out of $50 trillion in total domestic financial and non-financial sector private debt) be absorbed by this program, which is going to move $700 billion at a time.

The fact that the government still relies on a market for its bonds puts limits on the pace at which debt can be socialized. There has been a great demand for Treasuries of late as safe havens, so the first tranche or two should be absorbed easily. Bonds may even rally more as assets prices continue to plunge.

Later, after the bulk of the deflation has passed and the bond market is saturated, this demand will ease and the Fed will have to buy greater and greater amounts of bonds with newly created dollars. The government’s spending needs are infinite, but the tax base and bond market are finite, so this phase of inflation can lead to currency failure. That can be chaotic, because contracts become meaningless when currencies are worthless. Out of such episodes arose Napoleon and Hitler.

Econ 101: Savings = Investment.  Lesson: reward savers with deflation.

We should embrace deflation, not fight it, because it restores sanity. The irresponsible go broke, and the prudent are rewarded. When money is tight, prices need to come down, and this encourages the savings that will turn to investment after the dust settles. Those who were smart enough to go into this crisis with savings are the ones you want allocating the capital for rebuilding, not the swindlers who beg for newly printed ‘stimulus’ money for their pet projects.

Your neighborhood, a government housing project.

Let’s assume the program actually removes all bad debt from bank’s balance sheets. Once again, they are fully capitalized and ready to issue loans, with assistance of course from an accommodating Fed. That will ‘fix’ one side of the reflation machine. On the other side, borrowers will still be choking on their existing debt and in no condition to take on more.

So the next step on the road back to inflation city will have to be debt relief for borrowers. As the owner of huge amounts of mortgages, the government is likely to be a very accommodating creditor. Can’t handle $2000 a month? Well, just pay $1000, but promise to spend the rest, ok! Or it could offer a quickie default: we take the house, but you can rent from us for cheap. In either case, the government has title to an enormous amount of housing stock, so all of America takes on the air of an inner city housing project.

(A side note: Once government becomes your landlord, it has a lot more leverage to force the installation of whatever it wants in your home, from ugly fluorescent lighting and those ‘efficient’ toilets that clog, to monitoring devices for your ‘safety’.)

The Crash is the Market, and It cannot be stopped.

Crashes are the market’s way of correcting the perversions of bubbles blown by bankers and governments. They are not market failures. The Market never fails. It is a force of nature. Bankers and politicians can shackle us with their guns and laws, but they cannot change the way the universe organizes itself. Any scheme but freedom, the absence of force (such as theft, a form of which is inflation), will be thwarted by the Market. Tax cheats, corrupt politicians, crooked brokers, smugglers and prostitutes are as plentiful as the laws that create them. In the absence of force (as George Washington said, “government is not reason; it is not eloquent; it is force”), the Market will reward honesty and industry above all else. When force is used liberally, society rewards George Bush Jr and Angelo Mozillo.

The government has tried to thwart the Market for so long, from the New Deal to the S&L crisis and beyond, that the distortions have become too big to support, and this time the Market is taking its revenge. Saving some big banks and some borrowers is certainly possible with bailout programs (rent seekers should call their lobbyists ASAP to get on that list!). But $50 trillion is way, way beyond anything the government can handle, so there will still be massive debt deflation left and right, and asset prices will continue to crash.

Debt revulsion is the fly in the reflation ointment.

To reflate, we need willing and able borrowers and lenders (inflation is the net increase of money and credit, deflation is their net decrease). Even if all bad debt is taken off the books of both borrowers and lenders, can the Feds rekindle America’s affair with debt? The answer is yes, eventually, but it won’t be any fun this time.

If the government forces the issue before the Market has cleared the way for growth, people will only be willing to borrow again to protect against the decline in the value of currency. During the crash, currency will continue to gain in value, so for at least the next couple of years, borrowers are going to be very wary of debt. They don’t want to repeat this nightmare, and besides, with asset prices crashing, the economy in a tailspin, and new regulations restricting commerce, where on earth can investors profitably deploy this capital? China? Not so fast — investing abroad may be restricted. Even with a 0% loan, can borrowers generate any return at all in this environment? With poor investment prospects and no need to protect against inflation, few will be willing to borrow.

This is why the traditional reflation machine will stay broken. This is the machine that Greenspan operated for the bankers with such mastery. But try as Bernanke might, this machine will not start up again until money or credit is somehow flooded into the economy through other means.

¡Chavismo!

In Hugo Chavez’s Venezuela, people borrow not for productive uses, but to speculate in any kind of asset that will lose value at a slower rate than inflation plus interest. It is a sickening thought, because it totally perverts all economic decisions and leads to staggering waste. We have just experienced a milder version of this in the US, but at least we built a few useful things with the credit, though most will go to waste.

In Venezuela, people invest in new automobiles, sometimes fleets of them, because the sum of interest and depreciation on the vehicles is less than the rate of general price increases. Hence, cars bought new appreciate in Bolivars as they rust in driveways. Venezuelan society is in a later stage decay than the US, but it may resemble our future.

The new New Deal, and the Neverending War

So how do you get that stubborn price level (the rearward looking indicator, CPI, was negative in August — expect more and bigger negative numbers for many months to come) to start ticking up again with gusto? After a general asset price crash, which I emphasize cannot be prevented at this point, the government can spend and spend and spend.

If you think the bridge to nowhere was ridiculous, you haven’t seen anything yet. Our sociopathic leaders, with hearty encouragement by esteemed professors, seem to have no problem with the old Keynesian theory of burying bottles stuffed with cash and letting people dig them up. Hey, it puts people to work and raises the price level! Let’s all pray for more hurricanes while we’re at it. Think of the boost to GDP!

Expect lots of pork for ‘green’ energy projects, and expect those projects to cost more than they produce and have all kinds of perverse effects. Expect national ‘service’ programs (if mandatory, they are national enslavement programs) such as have been touted by Obama, Hillary and the media wing of the Fascist party (now the only party in power in the US).

We were all taught in school that although FDR’s valiant efforts helped put Americans back to work, what really saved the US from sinking into a big hole the earth was War, glorious War. How lucky of us to already have two of them going and plenty more enemies lined up just in case!