Driven by the Supply of Credit

Not much action in stocks… or gold… yesterday. So, let’s go back and see what we’ve figured out recently. For one thing: The middle class can no longer afford a middle-class lifestyle.

We’ve also confronted an awkward truth: America is more of an oligarchy than a democracy. A recent university study found that Washington often snubs the will of the democratic majority to serve the desires of the dirty dealing special interest groups.

And we coined a new word – “poligarchs” – for the teeming masses who enable it.

Former World Bank economist and author Richard Duncan came to visit yesterday. You may recall Duncan has developed an interesting theory about how excess liquidity affects asset markets:

 

“Milton Friedman said it was the supply of money that mattered. But he based that view on his analysis of the Great Depression. He was right. But about 40 years ago, credit money started to replace real money. Now, it’s not the supply of currency that matters. It’s the supply of credit.”

 

And here, we simplify Duncan’s conclusion: As long as credit is increasing at a healthy rate, markets and GDP go up. When they don’t increase, expect recession and bear markets.

 

total credit market debt owedTotal credit market debt owed in the US economy (includes financial intermediaries, so there is some double counting) – via Saint Louis Federal Reserve Research – click to enlarge.

 

Cheap Beer and Cable TV

Credit expansion began when Ike Eisenhower was still on the golf course. It has been expanding ever since, with more than 50 times as much today as back then. And today, finance and industry – not to mention asset prices – depend on it as though it were cheap beer and cable TV. Cut it off, and the economy goes into a gloomy funk. Says Duncan:

 

“The Fed knows credit must expand, or we have a depression. And today, debt levels are so high that a depression would be catastrophic. The disaster would be worldwide, not just in the US. And people would die.

Because a depression in the US would mean tens of millions… maybe hundreds of millions… of people in China and Southeast Asia would lose their jobs. Businesses would go broke. Governments would go broke. People living at the margin – with no savings – would soon be desperate. I don’t think our civilization would survive. That’s why the Fed will not allow a real credit contraction.”

 

For the moment, the sun still shines and credit is still expanding. Asset prices are still going up. But all that is set to change. Duncan:

 

“In the third quarter, excess liquidity will fall sharply. We should see much more volatility in asset prices. My guess is that before the end of the year we’ll see a disturbing drop in the stock market. The Fed will pause… interrupting its “taper” program. Then, depending on how markets react, it will probably hint at another QE program for 2015. That should send markets back up.”

 

Pilfering and Squandering

Duncan sees the situation much as we do. Up to a point. He sees the dependence on ever-expanding debt. He sees the catastrophe that comes when debt expansion stops. He expects, as we do, that the Fed will respond with more QE. All right so far. But he lacks our deep cynicism and insensitivity. He sees the tunnel, but he thinks he sees a flicker of light at the end of it.

 

“Governments can still borrow… and still expand credit. One way or another, they are going to try to keep the credit expansion going. So, instead of throwing money away, they might as well invest in things that might expand future output – new technology, new infrastructure, and new industries.”

 

Ah… but that ignores the oligarchs, poligarchs and the nature of government. Government’s primary concern is not to protect its citizens or their economy. Instead, it aims to transfer more power, status, and wealth to the elite who control it (the oligarchs).

And to do that, it must keep the masses (the poligarchs) sedated. As Charles Hugh Smith, chief writer at OfTwoMinds.com, explains:

 

“The State has two core mandates: enforce quasi-monopolies and cartels for private capital, and satisfy enough of the citizenry’s demands for more benefits to maintain social stability. If the State fails to maintain monopolistic cartels, profit margins plummet and capital is unable to maintain its spending on investment and labor. Simply put, the economy tanks as profits, investment and growth all stagnate. If the State fails to satisfy enough of the citizenry’s demands, it risks social instability.”

 

The feds will be the borrowers of last resort. But the money won’t be invested in a brighter future. It will be pilfered and squandered.

And then what?

 

oligarchy-394x600

The oligarchic pilfering and squandering network

 

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

 

 

 

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