To readers of THE CONTRARIAN TAKE, it will come as no surprise that we are fond of the Austrian School’s take on monetary matters, specifically the unintended consequences of monetary largesse – economic busts.
To Austrians, ALL economic “booms” founded on monetary largesse ALWAYS end in economic busts, roughly equal in size and intensity to the preceding booms. By distorting interest rate and price signals and, as a consequence, creating malinvestments that must eventually be liquidated, monetary booms NECESSITATE economic busts. This is true regardless of whatever short-term benefits the economy and/or financial markets appear to enjoy from this largesse. And whether that largesse originates via the creation of central bank base money (through central bank asset purchase and/or loan programs) or via bank-issued on-demand deposit liabilities in excess of bank reserves or what Austrians call uncovered money substitutes (when said banks are making loans and/or purchasing assets), in the end the result is always economic busts.
Our broad and preferred money supply metric – TMS2 (True “Austrian” Money Supply) – posted another double digit year-over-year rate increase in March, this one coming in at 14.5%. That makes 40 consecutive months of double digit year-over-year rate increases. To state the obvious, we are in the midst of a monetary explosion.
To Austrians, this not only means we are looking at another economic bust, but given the size of this building monetary boom, a bust with a real possibility of surpassing anything we have seen in the recent past. Yes, even the housing boom turn bust turn Great Recession.
Building on an essay we wrote in March, here’s the why, how and when on what we are dubbing the Bernanke Boom – Bust-to-Be, named after the man most responsible for its genesis…
The Bernanke Boom – Bust-to-Be in the Context of History
Let’s begin this discussion by sizing the current installment of monetary largesse; namely, the Bernanke monetary boom, against the monetary largesse that produced the Tech Boom-Bust at the turn of the millennium and of course the Housing Boom-Bust turn Great Recession of 2008-09.
First, have a look at the following two charts which compare the monetary inflation rates of the three boom-bust cycles as measured by TMS2. The first chart plots the year-over year rate of change in TMS2, cycle trough to trough. The second chart plots the cumulative change…
Now take a look at this table, summarizing the key cumulative metrics…
These graphics speak volumes. Now in its 44th month, the Bernanke monetary boom as measured by our TMS2 metric is up a cumulative 58% and tracking the now infamous Housing Boom-Bust monetary surge almost to a tee. Heck, at $3.1 trillion the Bernanke monetary boom is already 1.6 times the size of the monetary surge that produced the Housing Boom-Bust and a whopping 4.5 times the size of the surge that gave us the Tech Boom-Bust. What’s even more interesting is that the Bernanke monetary boom is still going strong. As noted above, the latest TMS2 reading shows it was sporting a 14.5% year-over year rate of increase versus the 9% and decelerating year-over-year rate seen in the 44th month of the Housing Boom-Bust cycle.
We think this kind of monetary largesse guarantees an economic bust. In fact, given the size of the monetary surge so far, it’s quite possible that the bust will rival the size and intensity of Housing Boom-Bust turn Great Recession. Worse still, we could be looking at something even bigger than that…
The Bernanke Boom – Bust-to-Be, Bigger than the Housing Boom-Bust?
Yes, there is a real chance that the coming Bernanke Bust could pack an even bigger punch than the Housing Boom-Bust. One simple reason… A lot more monetary largesse could be in in the offing.
We sight three primary inflationary forces…
First, it’s no secret that the European Central Bank (ECB) and Bank of England (BOE) are running their own asset purchase and loan programs in an attempt to inject money into their fragile banking systems. What is a bit harder to see is that the US banking system has become a major beneficiary of that money. You see, as illuminated by Kash Mansori in his essay Europe’s Banking System: The Transatlantic Cash Flow, many European depositors are quite skeptical of European banks and are taking their deposit money, now being generously fed by ECB and BOE largesse, and re-depositing that money in the perceived relative safety of US banks. The result is a nice push for the US money supply. Indeed, the ECB and BOE have exploded their balance sheet footings 54% and 38%, respectively the past twelve months. In US dollar terms that’s a combined increase of roughly $1.4 trillion or 44%. Yet, contrary to basic money mechanics, the Eurozone and UK monetary inflation rates are languishing at multi-year lows…
While it’s true that the ECB and BOE are fighting to offset bank asset liquidations and resultant deposit destruction, that’s only part of the story. The other part of the story is the fact that ECB and BOE largesse is being exported to the States, contributing nicely to that robust 14.5% year-over-year rate of increase in the US money supply.
We’re thinking that as long as the European banking system is considered suspect, the US banking system and therefore the US money supply will continue to be goosed by European deposit flows. In fact, given the mounting sovereign debt crisis that is Europe, this is likely with or without the help of the ECB and BOE. If the ECB and BOE see fit to continue to grow their balance sheets, all the more monies likely to be exported to the States.
Second, as we discussed in last month’s essay, with excess reserves of some $1.5 trillion (owing to three plus years of Federal Reserve asset purchase and loan programs) yield starved banks – buttressed by improved liquidity and capital ratios, a Federal Reserve and US government still cleansing bank balance sheets of mortgage and mortgage related debt and near zero rate funding costs maybe as far out as 2014 – seem more and more willing to pyramid up those reserves into money and credit; i.e., to create uncovered money substitutes by making loans and buying assets. Have a look at the recent rate of change metrics in uncovered money substitutes and a proxy for its obverse, commercial bank credit as compiled by the Federal Reserve (the later which represents roughly four fifths of total bank credit). Both have been marching steadily higher and are currently touching two and a half year highs…
As we noted in that same essay, assuming a conservative reserve ratio of 10% on bank deposit liabilities - the highest reserve requirement ratio on the books – banks could theoretically triple the money supply, and do it simply by buying government securities.
Now, we are not saying that banks are poised to triple the money supply, full stop. For one, banks have to be continually willing to forsake the 25 bps they receive on their excess reserves, as well as the instant liquidity those reserves provide, for higher yielding, riskier assets. Not a huge obstacle for yield starved banks that are back-stopped by the Federal Reserve, especially if the trade-off is US Treasuries or some other government-backed investment, but an obstacle that could give banks pause at some point along the way. Similarly, bank capital ratios will almost assuredly act as a constraint on bank credit expansion short of a triple – voluntarily or through regulatory edict – particularly if banks are stretching the credit curve. Then, of course, given our debt-laden economy, there is always the real possibility of a major credit event, carrying with it the ability to derail even the most yield-hungry banking system. And last but not least, if the money supply took this kind of explosive path we think it wouldn’t be long before the US dollar was trashed, making price inflation a national issue and thus forcing the Federal Reserve to halt its easy money policies. Having said all this, such constraints on bank money creation appear to be of secondary importance for now, meaning there could be ample room for some serious money creation via the banks before any of those constraints kick in.
Third, if European deposit flows and/or banks can’t muster enough monetary largesse to temporarily juice the US economy and payrolls at a level sufficient to suit a deflation wary Federal Reserve headed by a Chairman scared to death of a 1937 style double dip (which he attributes to the Federal Reserve’s move away from a accommodate monetary policy), rest assured there is always QE III or some other creative monetary tool lying in the wings ready to spike the money supply on the false belief that this will spur long-term economic growth.
The net of all this monetary largesse – what’s already been created and what’s likely still to come – is that the Bernanke monetary boom could very well be on its way to one of the great monetary inflations in US history and, as a consequence, one of the great economic busts in US history too.
The Trigger for the Bernanke Bust
Don’t tell me what, tell me when, right? Enter the trigger which will turn the Bernanke Boom to Bust… A cessation, even a marked deceleration in the rate of money creation.
You see, once the economy is deprived of its monetary steroids, the malinvestments created on the back of all this monetary largesse, indeed sustained by it, will be revealed as wasteful, misplaced capital and labor. The Bernanke Bust will ensue as those malinvestments are liquidated, the debt supporting them purged and the capital and labor they absorbed released. A look at the Housing Boom-Bust time-line is instructive and offers a glimpse into what’s in store…
Note the deceleration in the money supply beginning in the back-half of 2003 and its precipitous decline thereafter, knifing through the 10% mark in the second quarter of 2004 on its way to a trough low of 1% in the third quarter of 2006. Shortly thereafter, the subprime crisis was upon us. Roughly eighteen months after that, the Great Recession.
The event(s) that might bring on a cessation / marked deceleration in the rate of monetary inflation are many. We alluded to some of them above, such as a major credit event or a return of price inflation as a national issue, forcing the Federal Reserve to reverse its easy money policies. But at the risk of sounding too simplistic, we think such events, while important, should be of secondary focus. Given the predictive nature of the ebb and flow of the money supply, all eyes should be on the money supply.
Just Keep Printing Money, Problem Solved
You might ask, what if the money supply continued to boom ad infinitum, even if that simply meant Chairman Bernanke last man standing at the printing press. Could the Bernanke Bust then be avoided? Delayed yes, avoided no. The end game in this case would be a bust too, only this one the result of an inflationary collapse of the US dollar. Indeed, the surest way to create massive economic misery is via a concerted effort by a central bank to forever expand the supply of money and credit.
Quoting the great Austrian economist, Ludwig von Mises…
There is no means of avoiding the final
collapse of a boom brought about by credit expansion. The alternative is only
whether the crisis should come sooner as the result of a voluntary abandonment
of further credit expansion, or later as a final and total catastrophe of the
currency system involved.
In other words, the Bernanke Bust is coming, sooner or later, one way or another.
No comments:
Post a Comment