Thursday, May 25, 2023

Lemme Get This Straight...

So, the US is getting closer to defaulting, Fitch threatens to cut its AAA rating on US government debt, the politicians are arm wrestling and... the Fed signals its willingness to intervene in case the worst happens? Seriously???

The Fed previously intervened in the Great Debt Crisis of 2007-10 by bailing out banks, mortgage lenders, insurance companies and foolish speculators (yup, some investment banks were exactly that).  The Fed, basically, turned private debt into public by printing a (then) huge amount of dollars (see chart below).  In the process, it ballooned its balance sheet from $900 billion to $2.2 trillion within months.  It was the very first instance of Quantitative Easing (QE).

  • Round One: The central bank funded the bailout of some speculators and a goodly number of players in the financial sector.

The Fed Bailout (QE1) During The Great Debt Crisis

The Fed intervened again during the COVID pandemic by, literally, raining money from the federal helicopter (see chart below).  Only this time the amounts involved were truly epic: its balance sheet literally exploded from $4.1 trillion to $9.0 trillion. 

  • Round Two: The central bank supported a portion of household spending for a year or two.

The Fed Bailout (QE2) During COVID

So, lemme get this straight: the Fed is now saying that it is ready to intervene again to do what exactly? Bail out the entire Federal Government?  What will Round Three look like, if it comes to it? Purchase a portion of the entire federal debt (see chart below) and flood the world with worthless dollars? 

The Fed Bailout (QE3)????

Federal debt held by the public (ie excluding the Social Security Trust Fund) has exploded from $4 trillion to $25 trillion in just 15 years.  How much of it is the Fed  willing to buy? Some of ? All of it?  The Fed already has $5.2 trillion of Treasuries in its balance sheet (ie it owns them) - that's 20% of all Treasuries (excluding the SS fund). Looking at it another way, it owns Federal debt equal to 22% of US GDP.  How much more can it buy, before it turns the US into Zimbabwe?

 OK, OK... I am being an alarmist here, so let me rephrase.  

How much more can the Fed buy before it turns the US into the Weimar Republic.  Now isn't that better?

Wednesday, May 17, 2023

USA Default Warning

 Very quick post.

The US is inching towards default because of the debt limit situation, and markets are no longer ignoring the risk.  

Take a look at the 1 year Credit Default Swaps (CDS) for US sovereign debt (ie Treasuries).  Prices have soared to 150 bp, up  15-fold since early 2023. 

USA 1-Year Sovereign Credit Default Swaps

By comparison, 1 year CDS for Germany are at 3 bp,  Japan is at 5 bp and the UK is at 8 bp. Worried? You bet - literally!

PS President Biden declared that "the US will not default". Take a minute to think this through: if the world's largest debtor and issuer of the world's reserve currency is reduced to such statements... the game may not be over, but it is past its half-time, for sure.

Wednesday, May 3, 2023

Transiting From Permagrowth To Permaflat - Part Two

In the previous post I laid out the context for transiting our present socioeconomic paradigm from permanent growth (Permagrowth) to steady state, a condition I will call Permaflat.  In this post I examine the financial/monetary aspects of such a transition.  But first, a bit of history.

The last yoke on unchecked money creation was removed in 1971 when the US went completely off the gold standard (ok, going to zero bank reserves in 2020 is also significant, but in other ways). It was not an entirely bad idea, given the severe pressures created on the monetary system by OPEC's oil price shock.  Some ten years later, things got really ugly when inflation spiked to 15% and the Fed (ie Paul Volcker) had to throw the country into a deep recession in order to kill it. 

The relation between excess money creation and inflation is pretty obvious to anyone with a passing familiarity with basic monetary economics: if you create more money than is needed by the underlying economic growth you end up with inflation, created by the existence of money alone. For example, if you create 10% more money but the underlying economy only grows by 5% you could ultimately end up with inflation around 5%.  It's really a cocktail napkin calculation, but it's close enough.

If you need proof look at the chart below: M3 annual growth in blue, CPI inflation in red. The recent huge spike in money supply growth is scary, to say the least.

What is of more concern is that authorities/politicians seem to think that most all problems can be solved by running the printing presses.  Countries/banks/mortgage lenders become insolvent? Print money.  COVID strikes? Print money.  A major bank's liabilities need to be backstopped? Print money. A regional bank (or four) becomes insolvent and needs to be taken over by a behemoth? Print money.

But such money printing is also creating short term excess demand for goods and services, straining the Earth's limited resources.  It's as if  the enzyme critters are boosting their activity by using money as a catalyst.  Yet, the reactor vessel isn't getting any larger and the amount of corn/food is also ultimately limited,  no matter how much money is printed.  Money, after all, is an artificial construct based on faith alone.

Therefore, we could not limit Permagrowth until and unless we also hit the brakes on money/debt creation.  A transition from Permagrowth to Permaflat requires zero money growth.

More on that in Part Three.