Money From Nowhere

On Friday, the S&P 500 and the Nasdaq closed at record highs. It’s the first time both indexes have done so since December 31, 1999. Why such optimism? High profits, you say. But where do profits come from?

Households have less money to spend than they did 15 years ago. And companies cannot make money just by selling things to each other. The only explanation is that customers – including the US government – continue to borrow and spend.

Corporations borrow money to buy their own shares. Consumers borrow to buy products. Either way, the money comes “out of nowhere” and falls on balance sheets like manna from heaven.


the-us-federal-reserve-board-building-susan-candelarioThe great money temple, from whence fresh pronouncements shall issue today. How long before it floods us with fresh money again?

Photo credit: Susan Candelario


The Limits of Debt

US households appeared to reach “peak debt” in 2007. Now, the corporate and government sectors – not to mention students and auto buyers – are pulling up to their maximum debt limits, too.


Household debtCredit to US households and non-profits stood at $13.384 trillion as of March 18 2015 – still below the 2007 peak and declining in relative terms – click to enlarge.


“Everybody – including every corporation and government – has a capacity limit for debt,” says Swiss money manager Felix Zulauf. “Once they reach capacity, they stop buying. Then the additional sales turn to additional inventories, employees turn to jobless statistics, and profits turn to losses.”

Maybe the cycle will reverse soon. Maybe it won’t. But US corporate profits – already at record highs – can’t go much higher unless: (a) wages rise, (b) consumer borrowing rises or (c) government borrowing rises. None of which looks likely.

And without the hope of higher earnings in the future, why pay so much for stocks today? The S&P 500 is trading at 27 times the average inflation-adjusted earnings of the previous 10 years. Only twice in history have S&P 500 earnings, measured this way, been so pricey: at the peak of the dot-com bubble and right before the 1929 crash.

Ah, you might say, but this doesn’t account for central banks’ ultra-low interest rate policies. Without the supposedly “safe” income that bonds throw off, what’s an investor to do but reach for dividends and capital gains in the stock market?

But stocks are supposed to look ahead. You don’t buy a stock in anticipation of getting back the same thing you paid. You buy hoping to get more. And if prices have gone up because interest rates have gone down, what will they do now that interest rates are already down near all-time lows?

How much lower can interest rates go? (We’ll leave that question for tomorrow – I think you’ll be surprised.) In the meantime, let’s keep our eye on the US stock market. Why are stocks – and assets generally – so richly valued?


SP-and-PE10As of April 1, the CAPE (a.k.a. PE-10 or Shiller P/E) stood at 26.8 (chart by Doug Short/Advisorperspectives). Only the 1929 and 2000 mania peaks are still topping the levels of today – click to enlarge.


Here Comes QE4

“Nowhere” has provided a lot of money …

No one earned it. No one saved it. But here’s our prediction: Someone will miss it when it is gone! If the US money supply were a deck of cards, Uncle Sam has been slipping in extra aces for the last 44 years.

Between 1980 and 2008 these aces were in the form of current account deficits. The US bought more from overseas than it sold abroad, and financed the difference on credit. Fiat dollars went to overseas suppliers. Their central banks took the cash and sent much of it back to the US, where it was used to buy stocks and bonds.

From roughly 1990 to 2008, the flow of dollars into US financial markets from trade surplus countries (where exports exceeded imports) averaged about $400 billion a year.

According to the author of The New Depression, Richard Duncan, this money was an important source of the Nasdaq bubble at the end of the last century… and the sub-prime mortgage bubble at the start of this one. When those bubbles popped, the Fed came up with another source of liquidity – QE.

Take QE plus the amount of dollars accumulated overseas as foreign exchange reserves, subtract Washington’s borrowing (which drains liquidity), and you have what Duncan calls the “Liquidity Gauge.” Follow the gauge, he says, and you will know how loaded this deck really is.

For example, in 2013, low government borrowing combined with QE led to near record levels of liquidity. The S&P 500 reflected this with a 30% gain. What’s in store in 2015?

It doesn’t look good. Washington’s budget deficits are estimated to stay at about $500 billion a year until 2020. This will absorb a lot of liquidity to pay zombies. Also, the Fed has put its QE program on pause. If it stays that way, some liquidity would seep in from European and Japanese QE programs. But it would be fairly modest.

The only major source of liquidity would be from dollar foreign exchange reserves overseas. But world trade has slowed, greatly reducing those reserves. The result? Negative net liquidity for the next five years.

The bad news begins in the third quarter, says Duncan. Because income tax returns are due in the second quarter, it always brings in tax revenue to the US government. This reduces Washington’s need to borrow… leaving liquidity available to the stock and bond markets.

But in the third quarter, net liquidity is likely to turn negative. And the stock market is likely to correct. What then? The Fed will panic and announce QE4… and other measures. More on those tomorrow …


debt monetizationAlthough this chart is slightly dated (it shows foreign central bank monetization of US treasury and agency debt until December 2012), it illustrates that FCBs are an important factor in the liquidity game. The chart depicts a large portion of the recycling of the US current account deficit by mercantilist nations, which are usually blowing up their domestic money supply in the process. In the past two years, this has slowed down considerably though, as the US trade deficit has declined (chart by Michael Pollaro) – click to enlarge.


Image captions by PT


Charts by: St. Louis Federal Reserve Research, Doug Short/advisorperspectives, Michael Pollaro.


The above article originally appeared at the 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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18 Responses to “When Exactly Will the Fed Launch QE4?”

  • It’s an imaginary game with an imaginary currency with real world consequences.

    Unless or until you learn the difference between money and credit, you will continue to get your analysis wrong.

  • therooster:

    RedqueenRace … you stated : “When a loan is paid off the loan asset disappears, replaced by money. The money does not vanish.”

    That may well be true but does that not assume that the loan is paid off ? That’s where debt-currency theory runs into the real-world. Loans are defaulted on so the currency does not receive this “blessing”. Looks to me that there could be plenty of requirement for another source of liquidity to grease the economic wheels.

    I like a little yang with my yin ….

  • therooster:

    Rodney … I was born on the 4th of July …. my father was a coin collector …. I’m a networker and an e-commerce marketer. You could say I’m qualified to know a good payment model.

    When debt-free currency (bullion in this case) dovetails with instant global liquidity, it’s a subject worth looking at. I’m concerned that the world is drowning in debt … I’m a father …. yourself ?

  • therooster:

    The movement of the bullion currency, from account to account is FREE. There are no fees for sending and receiving. Go to 2:35 in the video. You’ll hear it right from the founder & CEO. That goes right to currency velocity (and volume) for the sake of the economy. When you get that sorted out, follow up with me and we’ll talk some more.

  • therooster:

    VB … I clarified the fees. I actually spoke to the VP of Marketing at length, yesterday. No fees to open an account. No fees to send and/or receive bullion between accounts, what I had referred to as transaction fees. (PayPal is about 3-3.5%). The 1% fees are only for the buying and selling of the bullion in terms of loading your account and unloading. The velocity of the gold currency is unhampered by any fees on a global basis. I think that’s a massive feature. It’s going to save me a bundle on my own transactions. I do some e-commerce marketing online. I pay hundreds out each month on the basis of receiving. Updated link:

    • VB:

      From my point of view, the main “service” that this site provides is the ability to pay (for things priced in fiat currency) with the gold you own. Each such payment is a “transaction” to me. Each such payment carries a 1% fee. (I had missed that buying gold for your account at them ALSO carries a 1% fee, but presumably one wouldn’t do that too often. Payments, on the other hand…) Apparently, there is no fee for sending gold (not payment in currency) to another person (I bet they would have to have a BitGold account too, though), but that’s largely irrelevant – how often would one do that?!

      Anyway, after doing my research, my mind is made up – I wouldn’t touch this service with a ten-foot pole. You’ve had your warnings, whether you choose to heed or ignore them is entirely up to you. But please stop pushing this service here; it is not appreciated.

  • therooster:

    VB : You may want to read my post again. I agree with you … now. Gold has no liquidity problem (as a currency) as long as the price is free to float and the market can scale up the price.

    If gold has a set price, as it did during Bretton Woods ($35 USD/oz) then liquidity (as currency) is restricted to the amount of monetary gold that’s on hand. Liquidity is proportional to the product of (weight x trade value/unit weight) —->>> (weight x USD/oz)

    If you want to raise gold’s liquidity (economic reach), you can now bring more weight out of the ground and finish it …. OR ….. you can allow the price to rise as per the market demands. There’s now a choice.

    If the price is FIXED, your only choice to raise liquidity is to bring more weight out of the ground. Given that bullion is a limited and finite resource, that prospect becomes a dead end street. You simply run out. Like anything else, if there’s a demand that exceeds supply, allow the price to rise. Nothing new.

    If you stand back, it’s actually western governments in concert with western central banks that set the stage for real-time gold and the ability to re-monetize gold in the age of information with real-time liquidity. That’s now up to the market.

    You cannot pour new wine into old wineskins.

    • VB:

      I agree that fixing the price of anything (including gold) is a bad idea. In my opinion, a PROPER gold standard is not using some artificial monetary unit (e.g., a dollar) and making it linked to (or even freely redeemable for) gold – the proper way is using standardized weights of gold as monetary units (e.g., gold grams). But, good idea or not, it isn’t going to happen any time soon (if ever) on national or international level. Services like BitGold just cover niche markets with very little demand.

      If you agree with me that gold is liquid enough, your statement “if you want to raise gold’s liquidity” makes no sense. Why would you want to raise gold’s liquidity if it is already the most liquid commodity around?

      Also, digging gold from the ground is by far not the only (or even the main) way of making it available. Most of the gold ever mined is still around, sitting in vaults and readily available as supply for the right price.

  • therooster:

    Help is on the way. All the market needs to do is support the notion of adding debt-free assets into circulation to circulate as currency. Think of it as a supplement to debt based liquidity. A recognition that this kind of asset based support must come from the market and must have organic growth is very important, IMO. Because we are operating in real-time, where currencies and precious metals have floating values, no “instant change” by fiat or by legislation is possible. The change MUST be a graduated change. It CANNOT be top-down. NO CRASHES PLEASE. Nobody wants to crash the debt markets or the fiat currency system that are quarterbacked by the USD. Rate of change is critical. (currently in beta testing)

    • VB:

      LMAO. Gold doesn’t have a liquidity problem – it’s one of the most liquid commodities. (It’s one of the reasons why it is useful as money, after all.) The world doesn’t suffer from a liquidity problem. The world suffers from a debt problem. The debt cannot be paid. It has to be written off – and that isn’t going to happen until the whole house of cards collapses.

      BitGold just offers an easy way to automatically monetize-and-pay-with your gold. Which is nice, if one can live with the 1% per transaction fee and the counter-party risk and the government sanctions in some jurisdictions – but it doesn’t solve anything.

      • therooster:

        VB … second part of my answer. I believe that there are no transaction fees for sending and/or receiving bullion with BitGold. Check again. The only fees are for loading gold (buying) into the platform and selling gold to come out of the platform. The gold is also callable if you want the bullion. There are no fees to move the bullion and the debt-free liquidity that greases the wheels of trade. No storage fees either.

        Are you aware that the circulation of debt-free liquidity purges debt out of circulation ? Bullion can add new liquidity (L2) to the existing debt based liquidity (L1) to increase total liquidity in the hybrid “Yin-Yang”. This allows existing debt based liquidity (L1) (fiat) to be drawn off and destroyed … not redistributed, but destroyed.

        • VB:

          Read carefully what I wrote. BitGold lets you automatically monetize-and-pay with your gold (that it stores for you). Yes, there are no storage fees or fees to send them gold. But each time you pay with it (i.e., on each transaction), there is a 1% fee. On EACH TRANSACTION. Compared to that, there are precious metals storage companies that charge you 1% (or even less) for storage ANNUALLY, not per transaction. You can argue whether the convenience of payment that BitGold provides is worth the expenses (this is something everybody should decide for themselves) but you can’t argue that it is free or even cheap, compared to other gold storage companies.

          Not to mention that, as I said, it doesn’t solve anything related to the problem we are talking about.

        • VB:

          OK, I watched the video. This is, of course, only a personal impression and I could very well be completely wrong, but these two guys raise an intense dislike in me. I can’t put my finger on any particular thing, but they pushed all the wrong buttons. “Bitcoin” (scam alert!), contradictions (“payments are free” – no, they aren’t; storage and sending gold around is free; payments have 1% transaction fee)… Googling around doesn’t increase confidence, “Nick Szabo”, “peer-to-peer currency”, “proof-of-stake”…

          It does seem legit (Soros and Sprott investing in it, in the process of being listed on the TSX) but personally I’ll stay away from it.

        • RedQueenRace:

          “Are you aware that the circulation of debt-free liquidity purges debt out of circulation ?”

          Purges debt out of circulation? Circulating debt? The only way that makes sense is if one accepts the “money is debt” contention. I do not.

          But let’s say that is true. Explain how this purge takes place. Aside from the destruction of the physical form of money, money is only destroyed by the central bank. Loans that are repaid return money to the banks but they are economic actors and will eventually spend that money back into the economy.

          At any rate, why would I want to pay in gold when people still accept paper? There is no totally opting out of the paper system while being a part of mainstream society, so some assets must be kept in it.

          The ideal is that the PMs I hold will never be utilized. If they are it means something has gone very badly, either in my personal life or within the financial/monetary system. I do not hold PMs and root for that outcome.

          • therooster:

            What I said was that DEBT-FREE liquidity purges debt out of circulation, the addition of debt-free currency (assets like bullion).

            Lets look at two pools of liquidity one debt based (Yin) and one asset based (debt free) (Yang).
            The yang side is obviously deflated right now and the yin side has been dominant for many years,

            When we add debt-free liquidity (bullion) (L2) to the existing pool of debt based liquidity (L1), the total of L1 + L2 will allow for L1 (debt) to be reduced and destroyed through conventional debt servicing. The L2 will organically make L1 more readily available to the hands that need it to return it to it “nothingness”

            Debt can only be purged by the addition of assets in circulation. The movement is key as a supplement for economic activity.

            Our current state of an inflated debt currency (L1) had to precede a move toward balance on the basis that the floating currency paradigm had to gain traction in the market before real-time priced gold could makes its monetary entrance. In terms of the order of creation, it is not much different than light coming out of darkness. The relationship eventually becomes quite symbiotic.

            • RedQueenRace:

              “Debt can only be purged by the addition of assets in circulation.”

              This is not correct. Debt is paid off out of cash flow, not money stock. The gold system would eventually not work if your statement were true.

              “The L2 will organically make L1 more readily available to the hands that need it to return it to it “nothingness”

              You missed my point. When a loan is paid down/off the bank receives money. But they are a business and thus an economic actor. They have expenses (payroll, taxes, rent or building maintenance/cap-ex if they own, business supplies, cleaning services, etc). They also share profits (dividends, stock buybacks, bonuses).

              Money that isn’t spent becomes part of the bank’s capital. While it is possible that they could park it with the Fed and thus contract the money supply it is more likely they will buy bills or bonds.

              When a loan is paid off the loan asset disappears, replaced by money. The money does not vanish.

    • rodney:

      Your posts read like an infomercial for; it doesn’t make sense to run these ads here: The blog traffic is not that big, and you also find yourself up against people who know what they are talking about. Perhaps you might try elsewhere?

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