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Don't Worry; They'll Just Change the Rules

Wednesday, January 12, 2011, 10:52 PM

To anyone paying the slightest bit of attention, these remain very uncertain and trying times. On one side of the intellectual divide are the folks who are counting on deflationary forces overwhelming the normal credit-operated machinery of modern life, resulting in an implosion of economic activity. On the other side are those counting on hyperinflation as the most likely outcome of the grand printing experiment currently being conducted across the globe with its epicenter located within the United States.

In the middle of the intellectual divide are people like me, who are leaning slightly towards one view or the other. Not yet committed to any particular outcome, they are tensed and ready to spring in whichever direction necessary, like the last kids left standing in a game of dodge ball.

Some are expecting an imminent recovery (whatever that means), some a long, slow grind downwards, and others a rapid, if not chaotic, plunge into new and unwelcome territory of one sort or another.

There are no right or wrong views here. All sides are on equally firm intellectual standing. However, I want to let you know why it is that I lean towards the inflationary line a bit (okay, a lot, by some people's standards) and why I think that a wide-scale, final fiscal collapse is in the cards.

More than a year ago I wrote an article entitled The Sound of One Hand Clapping, in which I framed the recovery in terms of bent rules, as opposed to what should be happening.

[Despite the bursting of a massive credit bubble,] everything just keeps perking along.  What gives?

The answer, I believe, requires us to ask a Zen-like question along the lines of, "What is the sound of one hand clapping?"  That question is, "If nobody recognizes a defaulted debt on their balance sheet, does it exist?"

Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist.  And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.

What does "deflation" mean in such a world?  Not much, as it turns out.  At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.

This is the world in which we currently live.  Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions.  If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.

But let me ask this:  What prevents the authorities from simply storing them out of sight forever?  Or at least long enough to allow the wave of liquidity to work its inevitable magic?  So far, much to my great surprise, they've managed to do exactly that, with hardly a squeak from the mainstream press (although the blogosphere is on the job, as usual).  I am now wondering if they cannot keep this up indefinitely.

While I certainly took some heat from the deflation camp for these comments at the time, my words herald almost exactly what has happened since then. Losses have been ignored, the Fed has dedicated all of its efforts toward repairing bank balance sheets, and nothing really bad has happened to the financial system. Yet.

With the recent revelation that the Fed engaged with companies and banks headquartered here, there, and everywhere in over 21,000 separate transactions totaling $1.5 trillion dollars, in a successful effort to prevent bad investment decisions from turning into a series of cascading defaults, I think it's safe to say that what should have happened (i.e., deflationary defaults) didn't happen.

Fed Documents Breadth of Emergency Measures

WASHINGTON — As financial markets shuddered and then nearly imploded in 2008, the Federal Reserve opened its vault to the world on a scope much wider and deeper than previously disclosed.

Under orders from Congress, the Fed on Wednesday released details of more than 21,000 transactions under the array of emergency lending programs and other arrangements it conjured up in response to the crisis.

At its peak at the end of 2008, the Fed had about $1.5 trillion in outstanding credit on its books. The central bank, in essence, pumped liquidity, the lifeblood of credit markets, into the circulatory system of an economy that was experiencing a potentially fatal heart attack.

At a recent event that I attended, which was heavily populated by political and monetary leadership, the view of most of the money types was that the "extend and pretend" strategy was a good and effective one. Others, like myself, argue that this 'mission creep' by the Fed involves taking on too many roles, doing none of them especially well, and risking much, including the Fed's reputation and autonomy (such as they are).

Changing the Rules

The theme here is simple enough: If and whenever the circumstances justify a major response, existing rules will be changed, altered, bent, or broken.

Because of this, I routinely argue that what should happen won't happen, at least not right away, and that there's really no such thing as investing anymore, only speculating -- unless you are a big bank, favored by the Fed, with advance information.

To the first point, what should be happening right now, with consumer credit well below its 2007 peak and the housing market in disarray, is a massive deflationary spiral. Losses should be piling up and swamping bank balance sheets. 

But they're not. Big banks are reporting record revenues and near-record profits, all thanks to Ben Bernanke's unshakeable decision to prop them up and bail them out. 

Wall Street banks see record revenue in recovery

Wall Street's biggest banks, rebounding after a government bailout, are set to complete their best two years in investment banking and trading, buoyed by 2010 results likely to be the second-highest ever. Even if this quarter only matches the third, the banks' revenue will top that of any year except 2009.

The surge has come after the five banks took a combined $135 billion from the Treasury Department's Troubled Asset Relief Program and borrowed billions more from the Federal Reserve's emergency-lending facilities in late 2008 and early 2009 following the collapse of Lehman Bros. Holdings Inc. Since then, the firms have benefited from low interest rates and the Fed's purchases of fixed-income securities.

"This is a once-in-a-lifetime opportunity for most of these banks, and I think they've recognized it as that," said Charles Geisst, a finance professor at Manhattan College in Riverdale, N.Y., who has written about Wall Street's history. "The profits they're making now will allow them to replenish their capital and take care of the other things they need to do."

Obviously, when you or I lose money on a bad investment decision, it's our own tough luck and we have to manage the fallout from it even if it wipes us out. But big banks? They get a free pass to go along with free money, and they are not even required to make a non-binding commitment that they'll try to lose less next time. I would absolutely love the opportunity to borrow money from the government at a low rate and lend it back to the government at a higher rate, but that program is not available to me.

It is not at all clear that the Fed isn't breaking a few rules along the way that supposedly govern what they can and cannot buy. Certainly they are bending the rule that forbids the Fed from directly participating in government debt auctions by turning around and buying that same government paper from big banks only a week after it was sold at auction by the Treasury Dept.

So I would invite you to consider that our expectations of what should happen, whatever they might be, should be tempered by the high likelihood that the rules will be changed as much as and whenever needed in order to keep the game working.

So far the deflationary impact that should have arrived by now hasn't, and a big reason why is because the rules have been changed along the way.

Here are some other "rules" that have turned out to be less concrete than they appear in print:

  • In the world of market trading, a trade is a trade. No backsies. Shortly after the Flash Crash™ happened on May 6, 2010, the NYSE (New York Stock Exchange) stepped in and arbitrarily drew a line above and below which trades that day were 'broken' or cancelled (effectively treating them as if they had never happened). The move to break trades was historically unprecedented. Many small-time traders felt that where the line was drawn favored big players who could influence exactly where the NYSE decided to wipe out trades. Confidence in the markets took a big hit, both because the Flash Crash happened in the first place (and was never satisfactorily explained, which suggests the root cause could still be in place) and because of the opaque and arbitrary manner in which the NYSE broke trades.
  • The CFTC (Commodity Futures Trading Commission) has position limits that regulate how many contracts, long or short, any one market participant can hold. At least on paper, anyway. In reality, J. P. Morgan and HSBC hold many times the position limit of silver shorts, and the CFTC has known this for years without taking any action besides holding a few meetings on the subject after much public pressure. Undoubtedly if you or I (or the Hunt brothers) were to try to amass a silver position that breached the position limit, we would be immediately and soundly prevented from doing so. Again, there is one set of rules for the big banks, and a very different set for everyone else.
  • High-frequency trading exists where certain participants are allowed to front-run sub-millisecond quotes, sometimes numbering in the tens of thousands per 'event' in order to divine price points and scrape pennies from every transaction using non-public data. Submitting a quote without the intention of having it filled is still against the rules, as is the use of non-public data, but the SEC (Securities Exchange Commission) has decided to prosecute a few penny-stock bucket shops instead of the probable culprits of the Flash Crash and provable destroyers of market confidence.

Again, the theme here is that when the circumstances call for it, the rules can and will be amended, ignored, or broken. Count on it. The sub-theme is that the well-connected get to play by one set of highly pliable rules, while everyone else must adhere to the much smaller footprint of hard-and-fast rules.

Conclusion - Part I

The worst that might have happened - a systemic financial breakdown - did not happen, and we can be thankful for that. But the alternative has had costs that are only now becoming better appreciated. With constant bending of the rules, the only constant was that every bent rule favored the big banks, often uniquely so.

With this special attention given to a favored few, the social mood darkened considerably among U.S. citizens, especially those far removed from the beneficial impacts of the Fed's largesse. Where states are struggling with extremely painful budget deficits measured in the single billions (in most cases), the Fed has been busy printing up and handing out some $75 billion per month to its coziest clients.

While millions of people ran out of extended unemployment benefits and lost houses due to completely fraudulent and illegal banking practices, ultimately nothing was fixed and seemingly nobody went to jail or was charged with anything. Small, regional banks without access to unlimited and essentially free capital from the Fed are now forced to compete with big national banks that have been granted an unlimited backstop by the Fed. 

This is how too big to fail leads to too small to succeed.

But anything that is unsustainable will someday stop, bent rules or not. In Part II of this report, I explore the idea of How This Will All End (free executive summary; paid enrollment required to access) by looking at the fiscal situation of the federal government and individual states and deriving a calculated estimate of when a final fiscal deterioration will overwhelm even the best of intentions. 

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32 Comments

JAG's picture
JAG
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Re: Don't Worry - They'll Just Change the Rules

Good report Doc.

After seeing the market levitate over yet another sentiment cliff, I'm reluctantly going to have to agree with your assessment here. But I can't help but question; what happens when the Fed's agenda and the profit margins of the big banks are no longer aligned? Insatiable greed has a way of making the impossible...possible.

Best...Jeff

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Re: Don't Worry - They'll Just Change the Rules

Everyone, please read The Creature From Jekyll Island.  Griffin provides bedrock historical material that lays bare the scheme to dominate the world by controlling the money.  Chris, fantastic work...as good as any you have done (that i have read).   Highly recommend Bill Sill who did The Money Masters and The Secret of Oz and Money as Debt by Paul Grignon.  These are the basic primers which when combined with the Crash Course provides what we all need to learn in order to understand what is being done to us.

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Re: Don't Worry - They'll Just Change the Rules

Jeff, the interests of the Fed and the Big Banks are the same!  The Big Banks are the actual owners of the private bank known as the New York Fed which is the power center of the Fed system.  It is two hands of the same monster washing each other!  Peter

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Re: Don't Worry - They'll Just Change the Rules

Brilliant and succinctly put.  Thank you Chris for your always well thought out analyses. 

Two years ago I questioned my entire analysis when I realized we weren't heading for a catastrophic economy despite every indication that we should be. One year ago, I figured out that the reason for that was because the people who write the rules got rid of the rules in order to avert a catastrophe. The rewrite necessarily meant that the TBTF banks and some others (GSEs etc) would be propped up with smoke and mirrors. The Fed "saved" the economy at the expense of the "little people." And by "little people" I don't mean everyone except the Wall Street movers and shakers and the big banks -there are MANY out there who are benefiting from this shell game. But there are many others - a majority - who sense something is wrong...who see their standard of living declining, maybe struggling to keep their home,  their kids graduating from 2nd/3rd tier universities with dim job prospects, their friends losing jobs and taking work that pays much less, fearful of their future and afraid of what the powerful might do next that will hurt them. I believe there is still a catastrophe headed our way and it will be the "little people," the honest folks out there, the salt of the earth who will endure the brunt of the pain. Unfortunately, they know something is wrong but they don't understand enough to fight it, if a fight is even possible. 

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ao
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Re: Don't Worry - They'll Just Change the Rules

Peter Smith wrote:

Everyone, please read The Creature From Jekyll Island.  Griffin provides bedrock historical material that lays bare the scheme to dominate the world by controlling the money.  Chris, fantastic work...as good as any you have done (that i have read).   Highly recommend Bill Sill who did The Money Masters and The Secret of Oz and Money as Debt by Paul Grignon.  These are the basic primers which when combined with the Crash Course provides what we all need to learn in order to understand what is being done to us.

Peter,

It's all been said and done here many times.  Check the archives.

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Re: Don't Worry - They'll Just Change the Rules

Here is a very interesting recent article on the inflation/deflation scenarios:

http://libertarianpapers.org/articles/2010/lp-2-43.pdf

The author posits that it will depend on who ultimately controls the central bank levers -- whether it is bankers (whom he says would prefer the relative stability of a deflationary environment) or politicians (whom would prefer to print money to satisfy various constituencies immediately).  He cites Japan as an example of the former and Weimar Germany as an example of the latter.

I'm not sure that I necessarily agree with his thesis or conclusions, but I think he framed the issues very well.  And I'm also not sure who has more influence over the Fed, but I would lean towards the bankers at this point.

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isjrb029
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Re: Don't Worry - They'll Just Change the Rules

As always Chris great report. It is amazing to watch and frustrating as well. I think you are right in they will continue to change the rules as we go along. The question is how long can they keep the game going. From what I see it will continue for quite some time.

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Re: Don't Worry - They'll Just Change the Rules

CM wrote:

In the middle of the intellectual divide are people like me, who are leaning slightly towards one view or the other. Not yet committed to any particular outcome, they are tensed and ready to spring in whichever direction necessary, like the last kids left standing in a game of dodge ball.

Or like me, feeling like the fly as he gazes out into space and sees the (federal) swatter perched in ready position above him, saying to himself, "This is probably not a good time to relax. Wings don't fail me now."

SS

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Re: Don't Worry; They'll Just Change the Rules

Chris

Your great insights and clear explanations of our situation are amazing.  I'm going to hurry over to Part II now.  Enrolled membership is well worth the costs.

Travlin 

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Re: Don't Worry; They'll Just Change the Rules

Oooooh! So well written and well said. Now I wish wish wiiiiish I were a paid up member to read Part II.

Question: If I bite the bullet and buy a month, do I see all the previous stuff or only stuff released in the next 30 days?

Poet

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Re: Don't Worry; They'll Just Change the Rules

You can go back in time once enrolled

Poet's picture
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Re: Don't Worry; They'll Just Change the Rules

jturbo68 wrote:

You can go back in time once enrolled

Thanks. I'll be looking into it, then, and talk with my wife.

Poet

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Re: Don't Worry; They'll Just Change the Rules

I just wanted to mention that part of the reason the NYSE and CFTC may not be responsive to the rules is that they are both run by former Goldman Sachs guys.  Goldman looks after Goldman and the big guys.  See comments by Joyce here:

http://www.goldmansachs666.com/2011/01/economics-and-goldman-sachs.html#...

mobius's picture
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Re: Don't Worry; They'll Just Change the Rules

It looks like Jon Nadler from Kitco also gets article title inspiration from Chris:

http://www.kitco.com/ind/nadler/jan132011.html

Greets! (greetings), Jo

JAG's picture
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Re: Don't Worry; They'll Just Change the Rules

Chris Martenson wrote:

Shortly after the Flash Crash™ happened...

Who trademarked "Flash Crash" or is this a joke?

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Re: Don't Worry; They'll Just Change the Rules

JAG wrote:

Chris Martenson wrote:

Shortly after the Flash Crash™ happened...

Who trademarked "Flash Crash" or is this a joke?

I did!

It's a joke.  By me.

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Re: Don't Worry; They'll Just Change the Rules

Poet wrote:

jturbo68 wrote:

You can go back in time once enrolled

Thanks. I'll be looking into it, then, and talk with my wife.

Poet

Poet -

How about this?  I will buy your 1 month membership subject to the following terms:

1.  If you truly find nothing worth reading on the Paid Member side of the house, that's it.  Let your month expire and we move on, no questions asked.

2.  If you find something of worth, pay it forward and buy a 1 month membership for another regular on the site who isn't a paid member.

That's it.

Let me know.

Johnny Oxygen's picture
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Re: Don't Worry; They'll Just Change the Rules

Howdy JEHR

Welcome to CM!

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Re: Don't Worry; They'll Just Change the Rules

Yeah I enrolled! 

I've been praying for wisdom like Solomon, so I am seeking the council of wise men.

I think the timing is perfect.  Thank you Chris

Poet's picture
Poet
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Re: Don't Worry; They'll Just Change the Rules

Dogs_In_A_Pile wrote:

Poet -

How about this?  I will buy your 1 month membership subject to the following terms:

1.  If you truly find nothing worth reading on the Paid Member side of the house, that's it.  Let your month expire and we move on, no questions asked.

2.  If you find something of worth, pay it forward and buy a 1 month membership for another regular on the site who isn't a paid member.

That's it.

Let me know.

Dogs

I appreciate the kind offer. If my wife and I decide to do enroll, however, we'll do it on our own. Thank you.

Perhaps someone else here may want to partake of your terms?

Poet

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Re: Don't Worry; They'll Just Change the Rules

Actually yes -- I'd love to take up that offer. I was just thinking of joining as well -- this post is just too intriguing to not read through to the end. 

TheRemnant's picture
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Re: Don't Worry; They'll Just Change the Rules

Shouldn't the title of this piece simply be changed to "There are no rules"?

If you can change the rules at whim, that's equivalent to saying there are no rules.

guardia's picture
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Re: Don't Worry; They'll Just Change the Rules

TheRemnant wrote:

Shouldn't the title of this piece simply be changed to "There are no rules"?

If you can change the rules at whim, that's equivalent to saying there are no rules.

It's more like they make the rules. You and me, we still have to follow them, so they are rules.

Samuel

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Re: Don't Worry; They'll Just Change the Rules

It is possible that both camps are right -- you can simultaneously have inflation and deflation.

I think it is certain that, on average, energy prices will continue to inflate. So when you're dealing with things that are driven by energy, count on inflation.

It may be difficult to think of things that are [i]not[/i] driven by energy, but those are the things that will continue to deflate. I would include things that [i]are[/i] driven by energy, but are non-essential. Think "big expensive houses that require a long commute." Think art, antiques, and collectables. Think non-essential, expensive gourmet food items. Think jewelry and fancy watches.

I'm banking that productive farm land will continue to inflate, even as second houses and big suburban McMansion real-estates deflate.

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Re: Don't Worry; They'll Just Change the Rules

Bytesmiths: how does the Little guy invest in productive farmland?

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Show me the pathway please

Chris, I have enjoyed and appreciaed your stuff since I fuirst found it a couple of years ago, but for now I'm firmly in the deflation camp for one reason; there is no pathway for the inflationary money into the real economy.

Inflation can only happen if there is too much money chasing too few goods and services but, as you and many others have pointed out, the money being created in the upper echelons of the financial establishment is staying in the banks to rebalance their accounts, it is not flowing into the real economy in which most of us live.

Because all the money being created is in the form of debt, the only way it can reach the real economy is to be loaned and there we hit the bottleneck.

The banks wont lend to anyone, individual or business, because our chances of paying it back are slim to vanishing and those who can afford to borrow are either busy paying down debt not increasing it, or buying up real stuff (land, screws, glues, fertilisers etc) whose production and availability will vanish when the shit finally hits the fan.

The only other pathway is massive government spending on infrastructure that entails literally armies of people to do the work, but that isn't going to happen under these people and, if it did, the work would be captured by the Halliburtons et al who would resile from paying for labour when they can buy big, expensive machines from their cronies in another big company.

I really don't think there IS a pathway for the money into the economy so I'm a deflationista, but if you can show one, and show that it is a reasonable bet, I'm more than happy to be convinced otherwise.

BTW, that doesn't mean prices wont rise, already my garden is saving me many $$ a week because food prices are going up, as is fuel, but those price rises are from genuine causes such as scarcity or rising production costs, not from the monetary phenomenon of inflation.

So, what is the pathway please?

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Re: Don't Worry; They'll Just Change the Rules

One thing the Fed isn't is an alchemist and they can't make silver out of nothing. From reading the blogs, it appears that there is hardly any left, a couple months' worth maybe. And the big investros know this. A default in the silver market could be the unextinguishable spark that triggers the collpase. This risk can only get worse, not better, as silver is used up industrially much faster than it is being replenshed, while gold isn't.

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Re: Don't Worry; They'll Just Change the Rules

One other question: wouldn't deflation just be a pit stop on the way to hyperinflation? Given how utterly worthless the dollar is, isn't hyperinflation inevitable when the world is forced to face reality after the ponzi scheme crashes?

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Re: Don't Worry; They'll Just Change the Rules

I agree with rlmrdl in that there is no pathway for inflation. It simply is not happening.

In fact, deflation continues in the housing market. While it is true that the reflation has continued in equities and to a lesser extent in commodities (the Reuters/Jefferies CRB Index regained 50% compared to the S&P500's 69%), I would argue that the reflation is in it's last throes. No doubt a lot of it has been driven by the large banks with the benefit of cheap money. The big question, though, is to whom will they sell in the future? No doubt, they have made large profits off the short sellers but at some point the shorts will say enough is enough but will be unlikely to become buyers - so how will those pushing the market up continue to do so without the help of the shorts covering? The investing public, which is more or less everyone outside of the largest institutions must be getting very wary of a market which is increasingly being seen to be far from a level playing field. I am reading the same sorts of comments on the internet and in the major financial publications that we were hearing in August-October 2007. As always, people (and that definately includes those trading for the largest institutions) become trapped by a sense of their own brilliance and their fatal linear thinking. The market will top and no amount of rationalisation ( better earnings, QE2 etc) will overcome the sheer weight of debt and unemployment.

With all due respect for Chris Martenson, his argument is just a conspiracy theory rationalisation for what has been going on. No one is in control - least of all the Fed. Money cannot be created out of thin air indefinitely without consequences. The common sense economics of the Austrians will hold sway. The Fed's huge expansion of its balance sheet from mid 2008 had no effect on the stockmarket which continued crashing throughout the QE1 buying program. Bob Prechter has recently pointed out the illogical aim of Bernanke (as claimed by the Fed chairman)  to boost the "wealth effect". As Bob Prechter notes, boosting prices for food, rent, gasoline and other commodities will more likely create a poverty effect for everyone which will be greater than the wealth effect for a few stockholders. In addition, Bernanke has claimed his purpose was to force down bond yields to make mortgages more affordable. Since when has inflation tended to cause rates to drop? In fact the opposite has been happening with rates rising over recent months.

rlmrdl has correctly pointed out that banks are not lending and people are tending to pay off debt rather than borrow. For the first time since the 1929-33 crisis M3 plus total credit market debt fell in 2008 and has not, so far, managed to get past its peak. As Bob Prechter describes it - It is a big deal. In fact it is deflation and it is signifying a turn of historical degree. For various cyclical reasons it may not be fully recognised for another year. Which is not to say that markets will not turn down in the near future but that the uh-oh moment will not be recognised for a while yet. Sentiment is still too bullish but that is exactly what is required for the turn in the markets to begin.

I do think that Chris Martenson is right in his description of what the Fed and the TBTF banks are doing - the manipulations, the rule changing, the lack of transparency, the dodgy accounting - but these actions all have consequences which will become uncontrollable. The manipulators may fiddle the numbers and the rules but they cannot control the mass mood which drives the markets. Quite the opposite, in fact. They are doing what they are doing because they themselves are subject to the same deterioration in mood - a lack of belief in themselves and in other people. In other words, it is fear that is increasingly becoming the driving force around the world. People are becoming more polarized and angry. It is a time for wealth destruction rather than creation. People neither want to borrow or to lend or to co-operate for mutual benefit. Wealth has become too concentrated, corporations have been getting bigger by takeover rather than by organic growth and just a handful of banking institutions control the world's credit supply. Despite that, banker's like Jamie Dimon consider that they are not big enough and have fought tooth and nail against the new regulations that have been brought in well after the horse has bolted. We are in an extremely vulnerable position. Common sense tells me that there are not enough fingers to plug the dike.

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Re: Don't Worry; They'll Just Change the Rules

Worries about inflation are meaningless when the main stream media has obfuscated any understanding of what inflation means.  Illargi on The Automatic Earth has it right when he says..."a clear view of causation is essential when it comes to defining your reaction to rising or falling prices, and prices that rise because of scarcity demand a totally different set of actions than those that do because of a rise in total supply of money and credit, combined with velocity of money, which is what inflation truly is."

What we facing right now in front of our noses is deflation.  Again, Illargi gets it right when he says..."Preparing for hyperinflation is not just useless at this point in time, it's also damaging in that it makes people blind to the real problem: deflation. And before we get to hyperinflation, if we ever do, deflation will cause so much pain and grief and unrest and death, that the very thought of hyperinflation will come to be seen as a highly delusional non-issue."

We are in a deflationary spiral as the velocity of money (95% credit), which is necessary to grease the wheels of the economy, slows down.  Chris is mistaken if he believes that if the TBTF banks and the FED just pretend that they don't have $Trillions in losses on their books then the problem will go away.  Extend and pretend will not last forever as every dollar borrowed to paper over this stinking mess incurs interest which is being loaded on the backs of the American people.  What we have is a political problem when the laws and regulations in the banking sector in our country are willfully not being enforced.  The rule of law is not being applied to the richest and most powerful organizations in the country.  This is not going to end well when the music stops.

Mark_BC's picture
Mark_BC
Status: Silver Member (Offline)
Joined: Apr 30 2010
Posts: 235
Re: Don't Worry; They'll Just Change the Rules

But timeandtide I don't think we can analyze this current deflationary environment in the same way as others like the Great Depresion because it's totally different. The US dollar has absolutely no inherent value anymore. In the 1930's the US dollar did indeed have a lot of value. And aren't all hyperinflations preceded by deflations? Aren't the two just brothers on the same pathway of economic destruction?

I agree that deflation is an inevitable event but the question is how long will it last and what will be its effects on the US economy at this point in time now versus any other time, ie what events would a deflationary spiral trigger and how long would that take ... given that the fundamental state of the US economy is beyond anything ever seen before in history. I guess what I am thinking is that given that a currency is simply a measure of the collective ability of a country's population to be productive and to pay off debts, then when you look at the situation in the US where most of its manufaturiong has been exported overseas, debt levels are beyond anything ever possibly serviceable (and this would only go up in a deflationary environment), and it is an oil dependent economy that can't power itself. Not only that, but because of its official reserve currency status, there are trillions more notes out there floating around outside of the country. Now, after a deflationary spiral where the productivity of its population is even worse, how could this currency maintain any value whatsoever, because it is fundamentally completely worthless, and will be even more so after deflation destroys the productivity of the workforce? Making a worthless currency twice as not-worthless through deflation is still worthless. When the financial institutions lose control then won't the world be forced to face this reality?

timeandtide's picture
timeandtide
Status: Bronze Member (Offline)
Joined: Apr 3 2010
Posts: 53
Re: Don't Worry; They'll Just Change the Rules

Mark_BC  - I don't think it gets one anywhere to try to figure what the US dollar is actually worth. It is a medium of exchange and its value will fluctuate against the euro/Yen/ Swiss Franc/Yuan/whatever. Since all paper currencies are issued by fiat, they are all suspect and their value relative to each other is based on little more than the market mood at any given time. It is pretty hard to talk about fundamentals when you are talking about trillions of dollars of credit based on nothing more than the productive abilities of a nation or a grouping of nations and the ability of their leaders to tax their people. The mistake most people make in the inflation/deflation debate is to focus on currency when the real issue is about credit which dwarfs the currency in circulation.

There are roughly US$970 billion currency notes in existence and more than half are estimated to be outside the US. The pertinent issue is the amount of credit in existence. Bank vaults are not stacked floor to ceiling with greenbacks. Banking today is about management of the ledgers which, collectively, add up to trillions of dollars.  M3 + total credit market debt topped out somewhere north of $60 trillion. This is an almost incomprehensible number (probably only comprehensible to those who "do God's work") and requires massive computing power to just keep track of it. It is mostly credit which has been issued too cheaply and as a result has led to monumental malinvestment - notably in housing. It makes up a major part of the "assets" festering on bank balance sheets.  Most of those "assets" will disappear like a puff of smoke when the US government/Treasury/Fed/Wall St accounting shenanigans can no longer hide the fact that many of the assets on their balance sheets are near worthless. The regulators are allowing the banks to maintain the fiction that their non-performing mortgages are actually worth something by letting these corrupt institutions book as income the phantom interest which is not even collected! ( see : 

http://blogs.forbes.com/robertlenzner/2011/01/12/us-banks-reporting-phan... )

These are the "tools" to combat deflation that Ben Bernanke and the other Fedmeisters talk about. This also means that the large earnings that many financial institutions are reporting are based on pure fiction.

Eventually, the deflationary impact of these assets evaporating (into the thin air from where they came) on the financial markets will spread to prices right across the board, including wages and salaries. We will most likely be dumped backwards by 30 years. It will be a huge recalibration. Those with large borrowings will be hurt the most. Good businesses which are not over-geared will survive, as will productive people. The parasites on society will find it very tough. The Zombies as so well described by Bill Bonner in The Daily Reckoning. The difference between the top and the bottom will narrow. Housing will become more modest and affordable again. Food and the farmers who produce it will be valued more than the financial engineers who have done so much harm. The elements of the environment (biodiversity, water catchments, forest reserves, the oceans etc) which sustain us will hopefully be recognised as crucial to our well being. However, my faith in humans being rational enough to consider the survival of the next generation is more limited. We may continue to ignore the many warning signs and push our most important resources to the point of collapse. A severe check now, in the form of a deflationary depression, would be tough but not the disaster that our rulers are trying to frighten us with. It would be a chance to regroup and do things better.

People who sit in ivory towers in the financial districts and governments of the world tend to see things in terms of numbers. For them it is all about how many points they can squeeze out of this transaction, what fraction they can skim off that high frequency trade or how many votes there are in that pork barrel. Economics and markets have been reduced to numbers and bloody algorithms. In reality, economics is about life and people. As long as people are alive and kicking there will be an economy, even if it is reduced to barter. Bartering does not usually last for long because paper, as a means of exchange, is so much more convenient. Paper has been abused several times over the last few centuries. This time it has been credit, which is even easier to play merry hell with because it does not even have a physical existence. It is literally not real - until, ironically, it disappears. That is what scares governments and bankers so much because they have borrowed more than anyone. I welcome a dose of reality.

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