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The bounce in Treasury yields witnessed after the election of Donald Trump is now decaying in the D.C. swamp. If the Federal Reserve continues to ignore this slow growth and deflationary signal from the bond market and continues along its current rate hiking path, the yield curve will invert by the end of this year and an equity market plunge and a recession is sure to follow.

An inverted yield curve, which has correctly predicted the last seven recessions going back to the late 1960’s, occurs when short-term interest rates yield more than longer-term rates. Why is an inverted yield curve so crucial in determining the direction of markets and the economy? Because when bank assets (longer-duration loans) generate less income than bank liabilities (short-term deposits), the incentive to make new loans dries up along with the money supply. And when asset bubbles are starved of that monetary fuel they burst. The severity of the recession depends on the intensity of the asset bubbles in existence prior to the inversion.

The Fed has traditionally controlled overnight lending rates between banks. That all changed when the Fed started to buy longer-term Treasurys and mortgage backed securities as a result of the Great Recession. Nevertheless, outside of these quantitative easing programs, the long end of the yield curve is primarily influenced by the inflationary expectations of investors. The yield curve inverts when central banks believe inflation is headed higher; but bond investors are convinced of the opposite.

The last two times the yield curve inverted was in the years 2000 and 2006. The inversion and subsequent recession that began in the year 2000 caused NASDAQ stocks to plummet 80 percent. The following inversion caused the Great Recession in which the S&P 500 dropped 50 percent and, according to the Case/Shiller 20-City Composite Index, home prices fell over 30 percent.

This next inversion will occur in the context of record high equity, real estate and bond market valuations that will require another government bailout. However, this time around the recession will commence with the balance sheets of the Fed and Treasury extremely overleveraged right from the start.

As you can see from the chart below, if the 10-year note yield (orange line) continues to fall along its current trajectory; and the Fed plods along with its avowed plan to hike the federal-funds rate (blue line), the yield curve should invert around the end of 2017. Market chaos and another brutal recession should soon follow.

What could prevent this baneful scenario from happening?

One of the most popular Wall Street myths is that long-term interest rates rise simply because the Fed is raising the federal-funds rate. This normally occurs because the central bank is trying to catch up to rising inflation and is initially behind the curve. However, later on in the tightening cycle long rates begin to decline as inflation is stamped out of the economy.

For example, from June 2004 thru June 2006 the Fed raised the fed-funds rate from 1 percent-5.25 percent; but the 10-year note only increased from 4.7 percent-5.2 percent. That means the benchmark note went up just 50 basis points even though the fed-funds rate was raised by 425 basis points. What is especially notable here is that GDP growth was well above 3 percent in both 2005 and 2006; as opposed to today’s environment of 1.6 percent GDP growth for all of 2016, and just 1.2 percent in the first quarter of 2017. The fear of recession and deflation is the primary reason why the 10-year note yield is currently falling.

The Fed has been tightening monetary policy since it started to taper its $80 billion per month quantitative easing program back in December 2013. It has subsequently raised rates three times and is now most likely already ahead of the curve due to the anemic state of the economy. But, as always, the Fed fails to read the correct economic indicators and is now fixated on the low unemployment rate and its dubious effect on inflation.

Some argue that the yield curve won’t invert if economic growth stalls because the Fed will then truncate its rate hike path. And indeed there is a lot of evidence for the second quarter recovery narrative to be proven false. For instance, April data on existing home contract closings declined 2.3 percent month over month, to a 5.57 million annual rate versus a forecast of 5.65 million. And new homes weren’t much better as single family home sales declined 11.4 percent to 569,000 annualized vs. the 610,000 forecast. Pending home sales also disappointed falling 1.3 percent. Then we had durable goods falling 0.7 percent, and core capital goods orders showed no growth at all.

These data points highlight the reality that the second quarter will not spring higher from the anemic first quarter growth rate. But the problem is that the fed-funds rate is already close to 1 percent. Therefore, even if we get just two more hikes before the Fed realizes growth is faltering, that rate will be near 1.5 percent. If the economy slows enough that even the Fed takes notice, the 10-year note yield should retreat back to where it was in July of 2015 (1.35 percent). In this second scenario, the yield curve inverts despite the Fed’s failure to consummate its dot plot plan.

Of course, there is a small chance that the yield curve doesn’t invert due to an aggressive reverse QE program — a very quick unwinding of the Fed’s $4.5 trillion balance sheet. While this may avoid an inversion of the yield curve, it would also siphon off capital from the private sector, as investors divert yet more money to the Treasury.

An aggressive selling of the Fed’s balance sheet is a very unlikely scenario given the minutes of the May Federal Open Market Committee meeting. In that meeting the Fed decided to merely taper the re-investment of its balance sheet, which is the pace in that it stops reinvesting its assets. With a total debt to GDP ratio of 350 percent, this third scenario has very low odds of occurring; but should remand the economy into a recession even if such a plan is deployed.

Therefore, the only rational way to avoid an inverted yield curve, market chaos and a recession is if long-term Treasury yields reverse their long-term trend lower due to a rapid increase in GDP growth. This would only occur if Trump’s agenda of repatriation of foreign earnings, tax cuts and infrastructure spending is imminently adopted. But the probability of this happening very soon is getting lower by the day.

An inverted yield curve will lead to market disorder as it did in 2000 and 2006. But this next recession starts with our national debt over $20 trillion dollars and the Fed’s balance sheet at $4.5 trillion. Therefore, when the yield curve inverts for the third time this century, you can expect unprecedented chaos in markets and the economy to follow shortly after. This is because the yield curve will not only invert at a much lower starting point than at any other time in history but also with the Fed and Treasury’s balance sheets already severely impaired.

There will be unprecedented volatility between inflation and deflation cycles in the future due to these factors. This represents a huge opportunity for those that can identify these inflection points and know where to invest. To be more specific, sell your long positions and get short once the curve inverts; and then be prepared to hedge against inflation when the Fed responds with helicopter money.

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It is ironic in a way that the Federal Reserve and its “rate hikes” have played a crucial role in setting back “reflation.”  There was some renewed hope up until that last FOMC vote in mid-March.  But since then, contrary to how markets “should” approach a higher federal funds band, bonds and funding have moved opposite. Swap spreads that for the first two and a half months of this year were decompressing, suggesting an easing in “dollar” pressure, began to compress (meaning for the 10s and 30s more negative) all over again after March 15.

It’s not difficult to assess why that was the case, where eurodollar futures, for example, could rise in price and therefore signal a (much) lower interest rate paradigm in the not-too-distant future despite the outwardly “hawkish” policy stance.  I wrote earlier this week:

“The markets ‘wanted’ the Fed exit to be the one that was described three years earlier, where ‘overheating’ was a more common term slipped consciously into policymaker speeches and media presentations. But the Fed only disappointed, with Janet Yellen at her press conference forced by less fawning questioning to admit, complete with the deer-in-headlights stare only she can give, that none of the models foresaw any uptick in growth whatsoever. Worse, the FOMC statement confirmed that though the CPI was nearly 3% at that moment, it was indeed going to be just a temporary artifact of oil price base effects, and that officially inflation was not expected to return to ‘normal’ until after 2019. Major, major buzzkill.”

In other words, as we have been saying all along, the Fed is exiting not because recovery is coming but because it never will.  There is, in their official judgment, nothing left for monetary policy to accomplish.  This pathetic economic condition, which they describe in their own way, through calculations like low or possibly negative R*, is now our baseline. What was unthinkable just three years ago (in the mainstream) is reality; ten years ago, it was plain impossible.

In January 2009, I wrote, “The economy is not likely to repeat the Japanese scenario.”  Unlike Japan, I reasoned, the American economy was far more dynamic and flexible, qualities that counterintuitively were on display at that very moment.  US businesses were laying off millions of workers every month, a horrible result for them but systemically what was necessary to restore profitability and cash flow.  Japan’s economy in the 1980’s and 1990’s was a contradiction of rigidity and a tangle of sclerosis, I thought, therefore its undoing and where the US would defeat the comparison.

Now so many years later, here the whole world sits in exactly the Japanese scenario.  Boy, was I wrong thinking that the Fed’s inability to affect the monetary system would be so easily set aside; or, if not so easily than overcome after enough time through good ol’ Americana.  I quite reasonably if naively assumed that faced with such incompetence on the policy level the far more dynamic American economy (which it was) would find its way out of that mess through other means. I had failed to appreciate the scale of the disaster on a longer timescale, how the eurodollar system had over the decades before entangled itself in everything here and everywhere else; and what that truly meant.

The most unambiguous and convincing evidence is how interest rates are low and have only remained that way no matter what, echoing what Milton Friedman wrote in 1963 about the 1930’s.  The issue cannot be business but money.

“The Federal Reserve repeatedly referred to its policy as one of ‘monetary ease’ and was inclined to take credit – and, even more, was given it – for the concurrent decline in interest rates, both long and short.”

He wrote again in the 1990’s warning the Japanese of the same condition, calling it the “interest rate fallacy” because though it is a clear sign of monetary tightness it is made unclear by economists who never seem able to understand money.  It’s a weird result for any central bank to be staffed with people who, at the top at least, can’t comprehend the nature of their own primary task.  It is far more so when it is a major central bank in a premier economy facing an historic liquidity situation.

It is downright criminal given the economic consequences of it, first Japan now the world.  The repeated situation strains all credibility, for the Japanese case was up to 2007 one of the most studied in all history.  How in the world could US (and European) officials end up making all the very same mistakes?

For one, US policymakers believed, in a way as I did, that they were superior to their Japanese counterparts.  In June 2003, the FOMC discussed these very scenarios and how the Bank of Japan was already at a place they increasingly believed they might have to follow.  QE had begun in March 2001 on that side of the Pacific, and was expanded after only a few months. In the US, the Federal Reserve had lowered the federal funds rate, what they believed was “stimulus”, even well more than a year after the official end of the dot-com recession.

By the start of summer in 2003, the short-term money rate was down to 1%, a level only a few years before that was thought beyond the pale of good monetary stewardship; so much so, that the gathered committee members at that meeting waxed philosophically about what they were doing, and even as Alan Greenspan contemplated what they really could do. The tone of that part of the discussion, centered on Japan and its experience at the zero lower bound that for the Fed had suddenly come into view, was “what if it’s us?”

“MR. KOHN.  Another problem in Japan was that the authorities were overly optimistic about the economy. They kept saying things were getting better, but they didn’t. To me that underlines the importance of our public discussion of where we think the economy is going and what our policy intentions are.”

That’s only true if you can be honest about it.  Japanese policy was only ever the same as American policy in that respect, for in all cases central banks believe they hold enormous power that given the will to use can only result in the preferred outcome.  Stimulus of the monetary type has been reduced to a tautology, or at best unchallenged circular logic; it works because it works. Or, as Ben Bernanke stated in his infamous “deflation” speech of November 2002:

“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

He made that statement which was received without controversy as a technical matter; philosophically, he was criticized in the Weimar Germany kind of way without thinking it all the way through. A year before, the Federal Reserve, as well as the Bank of Japan I have to assume, had already found startling contrary evidence, at least as far as quantitative easing was concerned.  QE as an operative scheme is simple and straightforward; purchase assets from private banks so as to increase the level of bank reserves, therefore satisfying Milton Friedman’s supply critique. That was the same argument that Bernanke was echoing in 2002, to raise the money supply through whatever means so as to achieve what he claimed and therefore expected.

Mark Spiegel, an economist at the Federal Reserve Bank of San Francisco, had published in November 2001 an account of some already serious deficiencies observed in the effects of QE then ongoing in Japan.  As everyone expected as a matter of basic central bank math, Japan’s M1 that had sharply decelerated in its growth rate reversed course with the introduction of BoJ’s bond buying scheme expanding so-called base money.  But, as Spiegel detected, in the real world it wasn’t so simple and easy:

“While M1 has indeed enjoyed robust positive growth since the inception of the quantitative easing strategy, there has been a matching decline in the aggregate known as ‘quasi-money,’ which includes time deposits and a number of other less liquid assets. While the central bank can increase the stock of narrow money in the economy, the banks appear to be treating the exercise much like a swap of near-zero and zero interest rate assets, and they are responding with little change in their lending activities.”

The US and global banking system after 2007 has acted in the same way, as both Japanese banks in 2001 (and after) as well as American and European banks post-crisis did more than just what Spiegel had described. This liquidity “swap” was indeed far-reaching, eventually over time eroding balance sheet factors in any number of ways.  I have tracked gross notional derivative books as a proxy for this very behavior, which suggests that in truth the conditions of bank balance sheets and therefore money in Japan as everywhere else is worse than even Spiegel spelled out fifteen and a half years ago.

We are left with one, and only one, conclusion; Ben Bernanke was right that the Federal Reserve as the duly appointed US government agency is in possession of the printing press.  However, quantitative easing no matter how much academic gloss it is given is not it. Actual monetary conditions are determined by a myriad of other outside factors (relating exclusively to bank balance sheets) that appear impervious to QE-type strategies, a verdict rendered by sixteen years of experience in Japan and another eight in the US and elsewhere.

You could have made a quantitative case against QE in the Japanese or the first American instances, where the “Q” part was simply too small.  In the last five years in particular that factor has, too, been empirically eliminated, most especially by the Bank of Japan’s QQE reaching now half a quadrillion in yen reserves with the same results (none positive).

Why the Federal Reserve merely followed in BoJ’s footsteps for all these years is almost inexplicable; almost.  Again, going back to that meeting in June 2003, policymakers here knew it wasn’t working and Alan Greenspan began to wonder about his own capabilities.

“CHAIRMAN GREENSPAN.  What is useful, as has been discussed, is to build up our general knowledge so that when we are confronted with the need to respond with a twenty-minute lead time—which may be all the time we will have—we have enough background understanding to enable us to make informed decisions. We need to know how the system tends to work to be able to make the necessary judgments without asking one of our skilled technical practitioners to go off and run three correlations between X, Y, and Z. So I think the notion of building up our knowledge generally as a basis for functioning effectively is exceptionally important.”

Or, as I put it a year ago, make sure you can actually do what you say you can do before you have to do it.  The emphasis was in 2003 clearly on the “before you have to do it part” and largely because of how the Bank of Japan was executing a theoretically sound strategy that wasn’t producing the desired or expected results. But they never did that. The FOMC as well as most of the academic literature instead focused on BoJ’s execution of QE rather than the technical factors that were clearly suggesting (really proving) from the very beginning at the very least far more complexity in money than was assumed.

And so it brings the world back to repeating the Japanese mistakes, as Governor Kohn described them so many years ago, “They kept saying things were getting better, but they didn’t.”  The Fed was never honest in its assessment of what it really could do so that by the time D-day arrived for them they were arrogantly dismissive even of direct market contradictions (especially eurodollar futures that were in early 2007 correct and have remained so despite all the QE’s).  It wouldn’t have mattered if the FOMC had their skilled practitioners run off and do X, Y, and Z correlations, because X, Y, and Z were all based on the same mistaken premises, those of Ben Bernanke’s 2002 speech. Throughout the crisis period officials kept claiming “things were getting better” (subprime is contained) only to see the whole thing nearly collapse.  Afterward it was always the same, “things were getting better” (green shoots) even though QE1 was followed by a QE2, another global liquidity crisis, a QE3, a QE4, and then another global liquidity crisis.

How can even the most robust and dynamic economy move even slightly forward under those conditions?  That is another result we have over the last ten years fully tested and established; it can’t. Whatever the unobserved direct effects of monetary tightness, such outward and visible instability is another depressive factor all its own, and a very important one.

Because of one simple variable we have followed a path that a decade ago was believed literally impossible. Indeed, everything that has happened this last period had it been described to someone in 2005 would have sounded totally insane.  And there is only one factor capable of creating that situation, the one, tragically, most experts were the least concerned about. Life does have a habit of unfolding in that way, where the one thing you don’t expect is what kills you in the end. Call it the maestro’s curse, no conundrum required.

We aren’t yet dead, though we are now living in John Maynard Keynes’ long run.  Apologies to Dr. Keynes, it does matter, quite a bit actually.  Chaos, whether social or political, is the inevitable product of extended economic dysfunction.  People will put up with a lot, a large recession and even a sluggish recovery, but no people (the Japanese have committed to demographic suicide) will be able to withstand the social consequences of unceasing bleakness and no legitimate answers for it.  Such a condition offends all modern sense of human progress.

It is a testament to how far down we have gone, that in 2017 pleading with the Fed to just say it one more time, “things are getting better”, because that is all that is left standing between the comforting fiction and the cold reality of Japanification.  It could only have been a bitter blow, for the Fed in truth was up until now good for only that one thing, meaning optimism; carefully worded, of course, but in the end constant positivity about recovery even if always off just over the horizon. For many, that fiction was more meaningful than being led unwilling to the truth about a world without growth.

Thus, all hope is not extinguished, merely transposed to right where it belonged all this time.  Central bankers have said “listen to us because that is the only way for recovery”; only now to say instead, “listen to us because there is no recovery” as if nobody is allowed to notice the change.  We need only stop listening to economists altogether because they were wrong then and utterly so now.  The problem isn’t economics but economists, the former having been removed from the latter generations ago.

That is the great unappreciated truth about Japanification. It was never about zombie banks and asset bubbles, at least so far as separate issues from economists who know nothing, prove they know nothing, and then refuse to learn when all results show it. Nobody ever bothers to challenge a central banker about money because who would ever do such a thing?  It is such a thin façade, though, as once you move past it to do so is incredibly easy.  One need read only a single FOMC transcript from 2008 (and now 2011) to establish this.

As “reflation” hopes fade just as they did three years ago, how the world proceeds is a choice.  It is a collective one, but one that must be made nonetheless. We can allow nothing to ever change as the Japanese have.  The political situation in Japan has been upended several times over the past quarter-century, but what is the one thing that has remained constant no matter which side sits in power?  The Bank of Japan.  Republican or Democrat, what is the one thing that hasn’t changed in America?  Monetary policy that was and remains strangely devoid of any money.

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The federal debt has gone from astounding to unbelievable to incomprehensible, a new problem has emerged: The US government is actually running out of places to borrow.

How Many Zeros Are in a Trillion?

The $20 trillion debt is already twice the annual revenues collected by all the world’s governments combined. Counting unfunded liabilities, which include promised Social Security, Medicare, and government pension payments that Washington will not have the money to pay, the federal government actually owes somewhere between $100 trillion and $200 trillion. The numbers are so ridiculously large that even the uncertainty in the figures exceeds the annual economic output of the entire planet.

Since 2000, the federal debt has grown at an average annual rate of 8.2%, doubling from $10 trillion to $20 trillion in the past eight years alone. Who loaned the government this money? Four groups: foreigners, Americans, the Federal Reserve, and government trust funds. But over the past decade, three of these groups have cut back significantly on their lending.

Foreign investors have slowed the growth in their lending from over 20% per year in the early 2000s to less than 3% per year today. Excluding the Great Recession years, American investors have been cutting back on how much they lend the federal government by an average of 2% each year.

The Fed is the only game left in town.

Social Security, though, presents an even bigger problem. The federal government borrowed all the Social Security surpluses of the past 80 years. But starting this year, and continuing either forever or until Congress overhauls the program (which may be the same thing), Social Security will only generate deficits. Not only is the government no longer able to borrow from Social Security, it will have to start paying back what it owes – assuming the government plans on making good on its obligations.

With federal borrowing growing at more than 6% per year, with foreign and American investors becoming more reluctant to lend, and with the Social Security trust fund drying up, the Fed is the only game left in town. Since 2001, the Fed has increased its lending to the federal government by over 11% each year, on average. Expect that trend to continue.

Inflation to Make You Cry

For decades, often in word but always in deed, politicians have told voters that government debt didn’t matter. We, and many economists, disagree. Yet even if the politicians were right, the absence of available creditors would be an insurmountable problem—were it not for the Federal Reserve. But when the Federal Reserve acts as the lender of last resort, unpleasant realities follow. Because, as everyone should be keenly aware, the Fed simply prints the money it loans.

A century of arguing about how much to increase spending has left us with a debt that dwarfs the annual economic output of the planet.

A Fed loan devalues every dollar already in circulation, from those in people’s savings accounts to those in their pockets. The result is inflation, which is, in essence, a tax on frugal savers to fund a spendthrift government.

Since the end of World War II, inflation in the US has averaged less than 4% per year. When the Fed starts printing money in earnest because the government can’t obtain loans elsewhere, inflation will rise dramatically. How far is difficult to say, but we have some recent examples of countries that tried to finance runaway government spending by printing money.

From 1975 to 1990, the Greek people suffered 15% annual inflation as their government printed money to finance stimulus spending. Following the breakup of the Soviet Union in the 1990s, Russia printed money to keep its government running. The result was five years over which inflation averaged 750%. Today, Venezuela’s government prints money to pay its bills, causing 200% inflation which the International Monetary Fund expects to skyrocket to 1,600% this year.

For nearly a century, politicians have treated deficit spending as a magic wand. In a recession? We need jobs, so government must spend more money! In an expansion? There’s more tax revenue, so government can spend more money! Always and everywhere, politicians argued only about how much to increase spending, never whether to increase spending. A century of this has left us with a debt so large that it dwarfs the annual economic output of the planet. And now we are coming to the point at which there will be no one left from whom to borrow. When creditors finally disappear completely, all that will remain is a reckoning.

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WASHINGTON — Let’s face it — Donald Trump is smarter than he looks.

For all the personality flaws the press loves to dwell on, the presumptive Republican nominee understands more about real world finance than all the deficit hawk politicians in both parties put together.

As he clarified his remarks about consolidating U.S. debt by buying back bonds at a discount when interest rates rise, he was setting the record straight on those who thought he meant to renege on the debt and effectively default.

Not at all, Trump said last week. And then he dropped another bombshell in explaining why that’s not even possible.

“This is the United States government,” Trump said on CNN. “First of all, you never have to default because you print the money, I hate to tell you, OK?”

Bingo. With a stroke, Trump demolished decades of homage by many economists and virtually all politicians to the straitjacket of a monetarist dogma that ignores the realities of present-day finance.

In fact, intentionally or not, Trump embraced a radical view of money and debt advanced by economists like James Galbraith, professor at the University of Texas and son of the legendary economist and presidential adviser John Kenneth Galbraith.

That view, known as modern monetary theory (MMT), holds that governments that control their own currency can print money without risk of inflation unless full employment creates excess demand because it is no longer tied to gold or some other measure of value.

“This is a Nixon-goes-to-China moment,” Randy Wray, a leading MMT exponent atBard College in New York, told Bloomberg, hailing Trump as “a Republican far to the left of the Democratic party apparatus who wants to promote rising living standards of Americans.” (President Nixon’s 1972 trip to China represented a major breakthrough in relations because of his past as a fervent anti-Communist crusader.)

Along with all his controversial views on immigration, terrorism, and trade, Trump is bringing a new perspective to public finance and to financial regulation based on his first-hand experience of dealing with real financial issues around the world.

 

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I haven’t had much time to write about economic theory in a couple of years, but this snippet is worth a response.

“People work in order to convert their time into a unit of account,” he said. “We call that money, and it’s an invention that allows us to store time.” Most people have stored little or none. So when they receive money, they quickly purchase necessities; food, shelter, health care. “People who are able to save money inevitably purchase real estate, stocks, bonds – all of which are alternative vehicles for storing time.” One share of Google stores 30 hours of work for the average American, or 30 minutes of copying-and-pasting formation documents for the average hedge fund attorney. “Bill Gates has stored enough time to fund a 1bln person army for 20 years.”

As the gulf between people’s income has grown, the amount of stored time has accumulated in fewer hands. “Wealthy people convert their hours into financial assets so that they can accumulate excess hours relative to their fellow man. But the average worker is simply thinking how to exchange hours for dollars and then exchange those for food.” Central banks face a different problem altogether. They need to get people who’ve saved time to exchange it for something other than clever inventions that store it. They’ve largely failed. So now, everything that stores time is extremely expensive and offers little or negative return, while the pace of economic activity slows. “The problem that we face now is that there is simply too much time that’s been saved. Another way of saying it is that there’s too much capital in the world, in too few hands.”

To restart the system, capital needs to exchange hands or be destroyed, spurring people to rebuild their store of time, rather than just save it. “It is an elemental truth that at some point, through inflation, war, or confiscation and redistribution, this imbalance will correct, and the system will then restart.”

The quote addresses ‘time preferences’. It addresses the choices available to any individual who is involved in an exchange of property rights. This is only addressed tangentially. Property rights are exchanged and stored as ‘money’. This rather begs the question, what exactly is money?

An individual can: [i] exchange money directly, [ii] hold money as cash, [iii] save [invest] money. These are all time preferences.

Investing requires free market interest rates. We do not currently have these as the Central Banks around to world seek to hold nominal interest rates low. There is still however the ‘natural rate of interest’.

In paragraph three, the author asserts that capital needs to be destroyed or change hands. Capital will likely be destroyed, but these are mal-investments.

Mal-investments  are predicated by artificially low nominal interest rates, which, we currently have and have had for quite some time, since the late 1980’s when Greenspan took over the Fed Chair.

Currently we are reaching the end game of artificial rates.

Of course should ZIRP/NIRP end, all business that exists because of these artificial rates, the mal-investments, will likely collapse, which is the destruction of capital that the author refers to.

This would almost certainly lead to a major bear market, which is the bear case. We saw a taste of it in 2008. The unemployment shot through the roof. There are not many ‘depression proof’ industries, the pain is felt everywhere.

Currently, the next internet/housing bubble is most apparent in social media, which relies on advertising revenue for almost 100% of its revenues. This is a problem and is a major destination of current mal-investments.

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In a new interview with King World News, Cashin warns that financial market conditions remain very risky. From the interview:

What I am saying is: They thought they were going to solve a desperate problem by desperate measures. I don’t believe it’s having the effect they wanted, and it’s building up a very, very dangerous situation. If that money were suddenly to get velocity, inflation could break out.

Conversely, by pushing on a string and not getting anything done, they may wind up being in a spot where, if the economy moves to stall-speed, we’ll get deflationary pressure. Yes, they’ve begun treating the patient with very, very drastic remedies, and my concern is: Is it ultimately damaging the body in a way that will bring back some of the horrors they tried to avoid?

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