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The Fed Can Only Fail

And we'll all lose
Friday, October 25, 2013, 12:34 AM

The basic predicament we are in is that the current crop of leaders in the halls of monetary and political power does not appear to understand the dimensions of our situation.

The mind-boggling part about all this is that it's not really all that hard to grasp.

Our collective predicament is simply this: Nothing can grow forever.

Sooner or later, everything must cease growing, or it will exhaust its environs and thereby destroy itself.  The Fed is busy doing everything in its considerable power to get credit (that is, debt) growing again so that we can get back to what it considers to be "normal."

But the problem is or the predicament, I should more accurately say is that the recent past was not normal.  You've probably all seen this next chart.  It shows total debt in the U.S. as a percent of GDP:


(Source)

Somewhere right around 1980, things really changed, and debt began climbing far faster than GDP. And that, right there, is the long and the short of why any attempt to continue the behavior that got us to this point is certain to fail.

It is simply not possible to grow your debts faster than your income forever. However, that's been the practice since 1980, and every current politician and Federal Reserve official developed their opinions about 'how the world works' during the 33-year period between 1980 and 2013.

Put bluntly, they want to get us back on that same track, and as soon as possible. The reason?  Because every major power center, be that in D.C. or on Wall Street, tuned their thinking, systems, and sense of entitlement during that period. And, frankly, a huge number of financial firms and political careers will melt away if/when that credit expansion finally stops.

And stop it will; that's just a mathematical certainty. It's now extremely doubtful that the Fed or D.C. will willingly cease the current Herculean efforts towards reviving this flawed practice of borrowing too much, too fast. So we have to expect that it will be some form of financial accident that finally breaks the stranglehold of failed thinking that infects current leadership.

The Math

As a thought experiment, let's explore the math a little bit to see where it leads us. After all, I did just say that a poor end to all of this is a "mathematical certainty," so let's test that theory a bit. I think you'll find this both interesting and useful.

To begin, Total Credit Market Debt (TCMD) is a measure of all the various forms of debt in the U.S. That includes corporate, state, federal, and household borrowing.  So student loans are in there, as are auto loans, mortgages, and municipal and federal debt. It's pretty much everything debt-related.

What it does not include, though, are any unfunded obligations, entitlements, or other types of liabilities. So the Social Security shortfalls are not in there, nor are the underfunded pensions at the state or corporate levels. TCMD is just debt, plain and simple.

As you can see in this next chart, since 1970, TCMD has been growing exponentially and almost perfectly, too. (The R2 is over 0.99, for you science types):

I've pointed out the tiny little wiggle that happened in 2008-2009, which apparently nearly brought down the entire global financial system. That little deviation was practically too much all on its own. 

Now debts are climbing again at a quite nice pace. That's mainly due to the Fed monetizing U.S. federal debt just to keep things patched together.

As an aside, based on this chart, we'd expect the Fed to not end their QE efforts until and unless households and corporations once more engage in robust borrowing. The system apparently 'needs' this chart to keep growing exponentially, or it risks collapse.

Okay, one could ask: Why can't credit just keep growing? 

Here's where things get a little wonky. But if you'll bear with me, you'll see why I'm nearly 100% certain that the future will not resemble the past.

Let's start in 1980, when credit growth really took off. This period also happens to be the happy time that the Fed is trying to (desperately) recreate.

Between 1980 and 2013, total credit grew by an astonishing 8% per year, compounded. I say 'astonishing' because anything growing by 8% per year will fully double every 9 years.

So let's run the math experiment as ask what will happen if the Fed is successful and total credit grows for the next 30 years at exactly the same rate it did over the prior 30. That's all. Nothing fancy, simply the same rate of growth that everybody got accustomed to while they were figuring out 'how the world works.'

What happens to the current $57 trillion in TCMD as it advances by 8% per year for 30 years?  It mushrooms into a silly number: $573 trillion. That is, an 8% growth paradigm gives us a tenfold increase in total credit in just thirty years:  

For perspective, the GDP of the entire globe was just $85 trillion in 2012. Even if we advance global GDP by some hefty number, like 4% per year for the next 30 years, under an 8% growth regime, U.S. credit would be twice as large as global GDP in 2043 (!)

If that comparison didn't do it for you, then just ask yourself: Why, exactly, would U.S. corporations, households, and government borrow more than $500 trillion over the next 30 years? The total mortgage market is currently $10 trillion, so might the plan include developing an additional 50 more U.S. residential real estate markets?

More seriously, can you think of anything that could support borrowing that much money? I can't.

So perhaps the situation moderates a bit, and instead of growing at 8%, credit market debt grows at just half that rate. So what happens if credit just grows by 4% per year? 

That gets us to $185 trillion, or another $128 trillion higher than today a more than 3x increase:

Again, What might we borrow (only) $128 trillion for, over the next 30 years? 

When I run these numbers, I am entirely confident that the rate of growth in debt between 1980 and 2013 will not be recreated between 2013 and 2043. With just one caveat: I've been assuming that dollars remain valuable. If dollars were to lose 90% or more of their value (say, perhaps due to our central bank creating too many of them?), then it's entirely possible to achieve any sorts of fantastical numbers one wishes to see.

Think it could never happen?

Conclusion (to Part I)

This is the critical takeaway from all of the math above: For the Fed to achieve anything even close to the historical rate of credit growth, the dollar will have to lose a lot of value. I truly believe this is the Fed's grand plan, if we may call it that, and it has nothing to do with what's best for the people of this land. Instead, it's entirely about keeping the financial system primed with sufficient new credit to prevent it from imploding.

That is, the Fed is beholden to a broken system; not anything noble.

In Part II: The Near Future May See One of the Biggest Wealth Transfers in Human History, we dive fully into the logic why GDP growth is very unlikely to support the rate of credit expansion that the Federal Reserve wants (or, more accurately, needs). And what will happen if it indeed doesn't? A lot of painful, awful things but central among them is a currency crisis.

Amidst the ensuing unpleasantness will be an awakening within today's hyper-financialized markets to the huge imbalance now existing between paper claims and ownership of real things. A massive wealth transfer from those with 'paper wealth' (stocks, bonds, dollars) to those owning tangible assets (the productive value of which can't easily be inflated away) will occur and quickly, too.

Suggesting the key objective for today's investor is answering: How do I make sure I'm on the right side of that wealth transfer?

Click here to access Part II of this report (free executive summary; enrollment required for full access).

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14 Comments

tonypee's picture
tonypee
Status: Member (Offline)
Joined: Mar 12 2012
Posts: 10
Fix the graphs

Nice article, but you need a linear x scale on the graphs, or they appear misleading. Please amend!

climber99's picture
climber99
Status: Bronze Member (Offline)
Joined: Mar 12 2013
Posts: 62
Nice one

Very good.  Blows my comments from previous articles about deflation out of the water.  One question?  Where is wage inflation going to come from in a weak labor market?  Somehow they have to engineer this as well.

climber99's picture
climber99
Status: Bronze Member (Offline)
Joined: Mar 12 2013
Posts: 62
Oh, just thought of something

You are only correct if the FED succeeds.  If it fails then my scenario of deflation, aka Japan, might come true. May have to call it quits after all.  Sorry Chris.

climber99's picture
climber99
Status: Bronze Member (Offline)
Joined: Mar 12 2013
Posts: 62
I'm confused

However, in the article you are saying the FED is engineering a currency debasement but in the title you put that it will fail.  Sorry folks, this is definitely my last post.  Ed

ErikAlbert's picture
ErikAlbert
Status: Member (Offline)
Joined: Oct 26 2013
Posts: 1
question

Re: "Now debts are climbing again at a quite nice pace. That's mainly due to the Fed monetizing U.S. federal debt just to keep things patched together."

Please let me understand this statement. Is it due to QE moneyprinting that there is reduced need for creating new debts? Is that the reason why the debt increase has slowed compared to before 2008?

Thanks very much for your reply.

bsammut's picture
bsammut
Status: Member (Offline)
Joined: Oct 1 2008
Posts: 3
"Deflation"

Historically, the real deflation is in terms of gold (real money).

The possible collapse into "deflation" would lead to massive QE.

Looks to me that the die is cast.  Janet Yellen will continue the $85 billion (1 trillion annual) bond and mortgage buying.  Wouldn't surprise me if it rises to $100 billion and ultimately higher.

Timing is difficult if not impossible; but, I think the cards are dealt and those without physical gold and silver will suffer.  I highly recommend the movie:  Soylent Green for an interesting forecast for 20??.

Cheers,

b

RogerA's picture
RogerA
Status: Silver Member (Offline)
Joined: Jun 18 2009
Posts: 106
Mathematics.

I see you mention math here. Just want to draw the attention to it, so we know what we are up against in times like this. Search connected mathematics.

A quote from a book called getting to know connected mathematics.

Standard 3. Mathematics as reasoning.
Through discussing the problems and their solutions, the students are learning to reason about the mathematics. They learn that mathematics is man-made, that it is arbitrary, and good solutions are arrived at by consensus among those who are considered expert.

Any wonder people do not understand our predicament?

Khannea's picture
Khannea
Status: Member (Offline)
Joined: Sep 28 2010
Posts: 8
Oh they know

The only way to reduce consumption of a rapidly expanding middle class is to destroy the value money represents. Crash it in to the relative value of oven tinder.

The problem with that is that the elites also lose the value of their investments. So the point of all this game of shells is to let the rich liquidate all their paper and turn it in to stuff that's really worth money. Real estate, real skills, actual natural resource claims, military contracts, crooked ass-kissing politicians that actually do obey when in a pinch, automated guns, robots, tech patents, factories. Big houses with lots of stuff. Yachts with hot tubs. Surgically enhanced porn stars with IQ 85. Drugs. More guns.

And that is precisely what has been happening. The rich displaced the capacity of the global middle classes to consume, probably by half in ten years. In terms of cons this is the best one I have seen. Feudalism has returned, and there's nothing the displaced can do about it, without ending up at Guantanamo and be labeled an enemy combatant. This isn't a bug. It is a feature.

Face it, stop whining, this is "the new world order".  They won, you lost. To the victor belong the spoils. Grovel and maybe they will let you live.

jibojabbajambobwana's picture
jibojabbajambobwana
Status: Member (Offline)
Joined: Oct 26 2013
Posts: 1
interest on so much debt?

who earns it?

what do they do with it?

do they pay tax on it?

seems like everyone in talking about debt, interest, unfunded liabilities and so on....

who earns the interest?

what do they do with it?

do they pay tax on it?

or am I just plain stupid?

dmaskal's picture
dmaskal
Status: Member (Offline)
Joined: Oct 30 2013
Posts: 2
Interest on debt to the Federal Reserve

The Federal Reserve legislation was written by JP Morgan and John D Rockefeller, while consulting wit the Rothschild family, and given to a Senator from Maine for introduction into the Senate.  The legislation was written so that those three families would be able to legally control all the individually owned banks throughout the nation.  After the legislation was written, and then, after concerns about cartels which many thought led to the Great Depression were expressed by President Wilson, modified to divide the Federal Reserve bank into regions to make it a law that the combined will of the heads of each Federal Reserve regions would basically have full power over all of the individual Banks that had been started nationwide.  This essentially created a banking cartel led by members of the Rothschild, JP Morgan, and Rockefeller families that has existed to this day, i.e for the 100 years.

The interest goes to the Rothschild, JP Morgan, and Rockefeller families who share a portion of it with the individual banks in the Federal Reserve cartel and with the Federal government.

How much is shared?  Nobody knows.  That's why legislators have been trying to demand an audit of the Federal Reserve.

dmaskal's picture
dmaskal
Status: Member (Offline)
Joined: Oct 30 2013
Posts: 2
The successfull 100 year fraud

The constitution of the United States of America gives the federal government and only the federal government the right to create money, and, anyone else is a counterfeiter.   In 1913 the legislation that created the Federal Reserve gave the banking cartel created by J.P Morgan and John Rockefeller, with guidance from the Rothschild family, the ability to legally produce counterfeit money and loan it back to the USA government.  The 1913 legislation that created the Federal Reserve, a misnomer since it was a privately owned banking cartel that was not controlled by the federal government, did not take from the Federal government its constitutional right to print money.  Nevertheless, since many legislators are owned by support they receive in their election campaigns from members of the Federal Reserve, the legislature has never assumed its responsibility for creating money.  Instead, the legislature just continues to borrow money from the Federal Reserve.

Time2help's picture
Time2help
Status: Platinum Member (Offline)
Joined: Jun 9 2011
Posts: 551
Currency ≠ Money

dmaskal wrote:

The constitution of the United States of America gives the federal government and only the federal government the right to create currency, and, anyone else is a counterfeiter.   In 1913 the legislation that created the Federal Reserve gave the banking cartel created by J.P Morgan and John Rockefeller, with guidance from the Rothschild family, the ability to legally produce counterfeit currency and loan it back to the USA government.  The 1913 legislation that created the Federal Reserve, a misnomer since it was a privately owned banking cartel that was not controlled by the federal government, did not take from the Federal government its constitutional right to print currency.  Nevertheless, since many legislators are owned by support they receive in their election campaigns from members of the Federal Reserve, the legislature has never assumed its responsibility for creating currency.  Instead, the legislature just continues to borrow currency from the Federal Reserve.

Ok, so does the constitution really give the federal government the right to create/print currency? At the state level, I remember there being a clause about coining in gold and silver only, was this not the case for the federal government as well at some point? 

Currency = Paper, Currency ≠ Money.  

My 2 cents (of currency).  

TomD2009's picture
TomD2009
Status: Member (Offline)
Joined: Aug 30 2009
Posts: 2
Ben Bernacke

I keep wondering about all the people who write that the Fed is somehow inept in its management of the US financial system without ever postulating that perhaps they are doing exactly what they were designed to do - eventually destroy the US economy.

It is good to remember that Big Ben wrote his doctoral thesis on the Great Depression and then actually helped create one in 2007-2008, although the ball-less media never used that term. The collapse of our economy was only a "recession". A recent article I found on Ben quotes Paul Samuelson on his opinion of Bermanke, who wrote his thesis under Samuelson at MIT. Here is the quote:

"The 1980s trained macroeconomics – like… Ben Bernanke and so forth — became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we’ve had…. I looked up Bernanke’s PhD thesis, which was on the Great Depression, and I realized that when you’re writing in the 1980s, and there’s a mindset that’s almost universal, you miss a lot of the nuances of what actually happened during the depression." (http://www.creditwritedowns.com/2012/03/samuelson-flunked-bernanke.html)

Ben simply is continuing the destruction of the US economy so skillfully begun by his predecessor, Alan Greenspan.

dadichris's picture
dadichris
Status: Member (Offline)
Joined: Apr 2 2013
Posts: 1
Total Debt MUST increase

Total Debt MUST increase exponentially.  This is an intrinsic imperative of the Monetary System.

Therefore, in the absence of exponential increases in private debt there MUST be exponential increase in public debt or the system will collapse.  The Fed has NO CHOICE but to continue QE to perpetuate the system. 

The only out is exponential growth of total Debt, Default or Debt Forgiveness.

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