More on the effect of credit and tipping points

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More on the effect of credit and tipping points

The term pushing on a string is frequently used to reflect the effectiveness of certain actions by monetary officials.  One of the "measures" of this term is the relationship between growth and debt levels.  In short if you add a dollar in debt, how much growth in GDP is there. Ideally it would be a 1:1 ratio, but that's a practical impossibility as the siphoning effect of interest and govt cost will eat up some of the growth.  Likely the best you could ever hope for would be something on the order of 1.2 debt to 1 growth.  I'm going to reference two articles.  The first I read about 10 years ago when I was admittedly financially naive in the big picture, having only begun to expose myself to the wonderful world of macro thought.  Of course now having 10 years under my belt I can now confidently say I know 10% of what one should know to be able to plot a future course. Tongue out The second is the current one by Contrary Investors whom I've read for about 7 or 8 years.  Both of these touch on some of the issues referenced by Machinehead in his posting of the Paul Kraseil article.

This first one I didn't really grasp at the time and I wouldn't say I have any omniscience at this point either, but it now makes more sense beyond my intuitive sense of "rightness".  It lays out the debtberg theory.  Pretty much it says you can push so much debt into an economy until you reach the zero bound and then the whole thing flips over and the more you try to push in you actually will get negative results.  That is to say your ratio will become something like 1 in new debt = -.2% in GDP.  Please bear in mind the age of the article and this is just a snippet.

All of this has some very insidious consequences!!!!  From Figures 1 and 3,
irrespective of the term of DEBT, the interest rate controls where the PEAK
occurs. ( hence formula  n = 1/(i)).   The real problem is that before the
PEAK, increases in the term of debt, or rollover, results in an economy
that can manage more DEBT.  However, after the PEAK,  successive rollovers,
or increases in term of debt, result in diminishing returns.  The economy
is able to manage lesser amounts of debt.    In other words, whatever works
before the PEAK, the opposite works after the PEAK.
So lets assume the economy is at a PEAK, and faced with diminishing returns
( a recession ), Mr. Greenspan decides to drop the interest rate.  This
moves the PEAK further out, the economy can take on more debt, and happy
days are here again as the economy just keeps on trucking!  How long can
this go on?  Obviously not forever, there is a limit how far into the
future this peak can be pushed.  Sooner or later one has to go past the
PEAK, when the fun really begins.  More outstanding debt than money means
higher interest rates, but higher interest rates mean the economy
accommodates less debt.  The only answer is massive defaults on DEBT
resulting in a big recession, or print money like crazy and have a nice
If I am right, Mr. Greenspan has made a serious miscalculation this time
around.  Around year 1997, I believe debt peaked, and in dropping the
interest rate, Mr. Greenspan cause that PEAK to move forward so the music
wouldn't stop.  When Mr. Greenspan raised the rate, in a sense he pushed
the economy over the PEAK where it could not sustain the debt an longer, so
LTCM collapse was the result.  Again, Mr. Greenspan is attempting to
forestall the PEAK with a rate reduction, but debt has already been pumped
up to such an extent, that if there is an increase in interest rates, the
economy whizzes past the PEAK with lightning speed,  and another round of
defaults precipitates.
The difficulty in all of this, is figuring out what to do.  At the start of
the K-Wave, playing with interest rates is no big deal, increasing them,
reduces debt,  while dropping the rate allows more debt to be piled on.
 Hence stimulative policies work miracles.  However, once passed the PEAK,
things work in opposite direction.  Dropping the interest rate results in
the opposite effect, that is decreasing the amount of debt the economy can
manage, and bringing a recession instead of a recovery, the opposite
desired effect.  If there is anything that will cause the FED to lose
control, this I believe will really be IT!!!

Now flash forward to today and the Contrary Investor article.

We see the message here as obvious and simple. Past a certain "tipping point" the more leverage an economic system assumes, the lower will be its ability to grow its economy. Certainly the irony of the moment is that as per the actions of the Fed/Treasury/Administration, it appears that these merry pranksters not only believe just the opposite, but are practicing such. Unfortunately the message of historical experience is ruthless and unambiguous. But just as unfortunate is that the powers that be are still married to the directional fiscal and monetary policies employed during the secular cycle of leveraging up systemically while it is clear as we all know that deleveraging is now the key systemic construct, especially at the household (consumer) level.

You Dream Of Columbus And There's Peace In A Traveling Heart...We'll make this summation short as we'll be addressing components of this in discussions directly ahead. First, why the occurrences of what appear to be macro tipping point anomalies discussed above? This should not be new news to anyone, but we are in the process of unwinding a generational credit cycle. This is a balance sheet recession that is fundamentally different than inventory led or Fed induced (taking away the punch bowl) recessions of the post war period. Yet we see the Fed/Treasury/Administration traveling down a remedial path assuming a typical post war recessionary experience. It is not. Secondly, as we hope we have elucidated above, there will be a downward bias to US domestic economic growth as long as the US government is levering up. Third, economic and financial market volatility and a certain sense of fragility should surprise no one. They are to be expected in the "new world" of the moment and factored into ongoing decision making. For now, we find ourselves within the confines of a range bound market where active asset allocation and a focus on risk management are primary behavioral objectives.

I apologize for the clumbsy posting, I'm having some difficulty learning this software.

This may be a giant leap in thought, and its entirely intuitive, but I have the very real sense that under the current global monetary scheme, hyperinflation going forward may well be impossible - in a very real sense we already did it.  I'm growing to beleive that further attempts at inflation may well only reinforce deflation.

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