GUALFIN, ARGENTINA – Investors were cheered up last Friday by the jobs report, which showed that the number of new jobs is about equal to the high set back in 2006 – just before the last crisis.
As near as we can make out, it is just noise.
Mountebank Market
So let us continue with our description of the Great Mountebank Market of 1987–2018. It wasn’t… and isn’t… what investors thought.
Investors thought they were making money by funding America’s win-win industries. But they weren’t investors at all; they were speculators.
And they weren’t providing the capital for real growth and prosperity.
Instead, they were unwitting participants in the Fed’s flimflam, stealing money from the Main Street economy and transferring it to the moneyed Wall Street-oriented elites.
Super investor Warren Buffett has said many times that “you don’t make money by betting against American business.”
An old-timer warning would have been more appropriate: “Don’t fight the Fed.” For the last 30 years, the fix has been in.
Winged Dollar
It’s win-win that builds real wealth. But win-lose is what has been driving stock prices.
In 1971, the feds replaced the old dollar with the new dollar. Alike in every other respect to the old one, the new dollar had one critical difference: It had wings.
The old dollar was weighed down by gold. It could never get off the ground.
It was limited by time and resources. If you wanted more dollars, you had to earn them the old-fashioned way – by providing goods or services.
That was how the Main Street economy worked. It created wealth. And the people who created wealth earned dollars.
The old dollar helped make America the biggest exporter in the world, with an unbroken chain of export surpluses reaching back more than a hundred years.
But the new dollar could be gotten without satisfying a single customer. It was not earned on Main Street. Instead, it was created, by the credit industry, on Wall Street.
Nor was it limited to the wealth the economy could produce; the banks – aided and abetted by the Fed – could create all the dollars they wanted by lending money at EZ rates.
An economy, or a household, can only support a limited amount of debt. Historically, America’s relationship of debt to GDP was 1.5. That is, for every $1 of revenue, the economy could comfortably support $1.5 in debt.
In an honest economy, there are only two sources of purchasing power: either you spend your own income (past or present) or you borrow someone else’s savings.
This naturally limits the amount of spending. People don’t earn an infinite amount of money. Nor do they save an infinite amount. Credit (or debt) cannot exceed the amount of savings available (with an allowance for the elasticity of the fractional banking system).
And there is a further limitation. People lend their savings out carefully, at interest rates that give them a decent return on their money and protect them from the risk of loss.
Pre-1971, the system was self-regulating. If consumers borrowed too much money, the pool of savings dried up. Interest rates rose. Lenders stiffened their backs. And consumers had to cool it.
Internationally, the same feedback loop kept accounts in balance. If Americans bought too many goods from overseas, foreign banks showed up at the Treasury demanding gold in exchange for their paper dollars.
The Treasury dutifully honored its obligations, as it had done for at least six generations.
But this reduced the supply of gold… upon which the dollar rested, in effect reducing the available money supply and forcing up interest rates. The resulting correction dampened consumer appetites, shifted the trade deficit to a surplus, and allowed the money supply to recover.
Out-of-Whack System
The new money system didn’t need no stinkin’ savings. Or caution. Or market-discovered interest rates. The Fed could create as much new credit as it wanted and lend it out at (almost) whatever price it cared to put on it.
This changed everything. Americans could spend much more overseas than they earned by selling goods to the foreigners, year after year.
The total accumulated deficits from 1971 to the present toted to nearly $20 trillion in today’s money. Debt soared to the rafters… and then went through the roof.
U.S. government debt, for example, rose from less than $1 trillion when Ronald Reagan took office to more than $20 trillion today.
Total debt rose similarly. From 1.5, the debt-to-GDP ratio rose to 3.5.
Today’s GDP is around $20 trillion. At the historic ratio, the economy could support $30 trillion of debt. Instead, it has $68 trillion.
This gives us a measure of how out-of-whack the whole system has become. And it also gives us a hint of what kind of adjustment would be necessary to bring it back into whack.
About $38 trillion of debt… debt-fueled asset prices… and debt-driven GDP… would have to disappear.
Excess debt, made possible by the fake dollar and the Fed’s EZ money policies, flattered and distorted prices throughout the economy.
Corporate sales were fattened by $38 trillion worth of excess spending over the four-decade-long period. Corporate profits were favored even more.
Typically, corporations earn money and pay wages. The wages are what consumers use to buy corporate products. Wages are usually a major business cost.
But this new spending came from neither savings nor from wages. It came from borrowing fake money. Corporate profits rose as companies got extra income with no offsetting wage expense.
And the entire stock market rose up, as if on a cloud of deadly gas.
Fake money, phony profits, counterfeit interest rates – all swirl together in a noxious ball of highly volatile fumes.
And now, the Fed – reversing 30 years of policy – strikes a match.
After its artificially low rates, and its quantitative easing… it intends to engineer a “soft landing” using its quantitative tightening policy.
Instead, it is likely to blow the whole system sky high.
Stay tuned.
Regards,
Bill
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Category: Central Banks