I was reading Gary North’s Issue 827 – January 27, 2009
BEN BERNANKE’S WILD RIDE (AND OURS)

He states “This money has entered the banking system. There are two
things the banks can do with this money: (1) keep some or all of
it on deposit with the FED, where the public cannot get its hands
on it; (2) purchase investment assets from the public, which
means that the fractional reserve banking process will take over
and turn the monetary base into spendable money. If the banks do
the second, the money supply will more than double. Prices will
then more than double. We will go over Inflation Falls.”

Well, if they do the first, we will have, as he and I have and others have said, default, deflation and depression. So, they must and eventually will do the second but that will NOT cause inflation.

When they decide to lend, WHICH IS HOW THE MONEY SUPPLY BECOMES A MONEY SUPPLY, who is qualified to borrow?

THE CAUSATIVE FACTOR OF THE COLLAPSE IS DEBT SERVICE. A collapsed economy cannot inflate its way out of debt service because the income out of which to service the debt collapses with it.

There is no way that any significant amount of FURTHER consumer debt can be qualified for, even enough to offset the current collapse. To generate enough CONSUMPTIVE money supply to apply upward price pressure is empirically impossible.

Unemployment is not a leading indicator; it does not appear at the beginning of a recession. Companies hold on to their employees in the early phase of a slowdown. Job loss is being touted as the measure of the recession but it is somewhat downstream in the destructive food chain. Not only that but IT FAILS AS AN INDEX OF THE QUANTITATIVE DEGREE OF CONTRACTION AS IT DOES NOT ACCOUNT FOR THE CONTRACTION THAT RESULTED IN JOB LOSS FOR ILLEGALS!

The stock market crash is not just a loss of asset value; it represents a contraction of the spending derived from wealth transfer. Monetary velocity is a phenomenon of goods and services being delivered in return for money; ergo, no commerce, no velocity. Velocity is slowed down due to falling asset prices because those wishing to sell assets (savings) so as to become spenders reluctantly remain savers. They do not want to spend the assets at a depressed value.

So how much contraction are we now experiencing from this? Big sticker items are purchased from savings accounts or asset sales, most probably the latter. Here on the Oregon coast we are seeing $300K lot sales falling through due to depressed stock value and then the $600K to over a million dollar construction projects that the potential clients could then qualify for don’t get built. That’s a lot of de-stimulus that is not staticized.

Obviously, whatever job creation or tax relief does get into the system, it will not manifest itself in any significant “savings” going back into the equities markets. So, a major factor necessary to re-build the economy to a working equilibrium is nowhere in sight.

In April 2000 I wrote “One man’s savings becomes only a perception while simultaneously becoming someone else’s spending money. The fattening up of the economy through this via was facilitated by the easy money on gains taken and the perception of wealth in positions held. That easy money fed a purchasing frenzy and the perceived wealth made it easy to let go of any other discretionary income. Naturally, as the seemingly endless cycle of Buy low/Sell high came to an end, that impetus ceased to exist.”

That was when we were entering the last recession. Then, by early 2001 ‘they’ embarked on the easy money equity finance and credit cards for all; kids included, and kept the machinery running until recently. So, now what is being seen by our leaders as “Too big to fail” is actually too big not to.

It’s as simple and as empirical as the action-reaction law of physics. THE AMOUNT OF ECONOMIC EXPANSION BUILT ON ADVANCED CREDIT WILL BE FOLLOWED BY AN EQUAL AND OPPOSITE AMOUNT OF ECONOMIC CONTRACTION.

In early 2001, on the USA Gold Forum a major debate raged over the then inflating money supply causing Hyperinflation. The following two posts were my view of the situation at the time and have turned out to be accurately predictive of what is now occurring and where, depending on what “They” do, it will go from here.

Feeding Leviathan: Sunday 1/28/01 8pm

It is the size itself of the American GNP and infrastructure that is the source of the dollar being the global reserve currency. This recent boom of historical proportions has created an economic animal of gargantuan size and akin to a biological animal, it must be fed and maintained in order to survive.

Recently, I said I would build a case as to why this and successive interest rate cuts will not be inflationary. In embarking on this crusade, almost as an infidel against the established order, I find that the inter-connectivity of economic events expands far beyond the bandwidth of the largest of viable posts. So to the reminder from Robin “That’s what they invented chapters for,” here is #1

New Loans For Old.

A few weeks ago, I mentioned that we had been solicited by our recently acquired mortgage holder to re-finance at a lower rate. This is a large mortgage granted on the basis of an excellent credit record, an appraisal and two months of bank statements. That’s it. Then in only six months they are asking to do it again and pay off any new unsecured credit debt to boot. Well we properly surmised that some lending body was well aware of impending interest rate cuts and seeking to lock in prevailing rates. Also, that the regulatory folks were still bending over backwards to make it easy for everyone to qualify. — Why?

This economy has been brought to it’s present size by unprecedented liquification of purchasing power and is now depended on that quantity to maintain it’s existence. But, some of the factors that contributed to this growth are tapped out. The two most critical are the stock market wealth factor and the record amount of credit.

Over at the Hall of Fame (There’s no such thing as money in the market) I’ve expounded at great length as to how one man’s savings becomes only a perception while simultaneously becoming someone else’s spending money. The fattening up of the economy through this via was facilitated by the easy money on gains taken and the perception of wealth in positions held. That easy money fed a purchasing frenzy and the perceived wealth made it easy to let go of any other discretionary income. Naturally, as the seemingly endless cycle of Buy low/Sell high came to an end, that impetus ceased to exist.

Simultaneously, the credit expansion having gone where no loans had gone before, tapped out at 125% mortgages and lending criteria that expanded to where there probably wasn’t a sane underwriter left on earth. That flow too is no longer in play. Therefore: My view is that these flows must be replaced and that the lowering of interest rates will perform that function rather then expand or inflate the economy.

Consider: While all that raging hormonal spending power was feeding the beast we did not have rampant inflation. I have maintained that the exact cause of price inflation is the “power to command price” by whatever means that power can be obtained. The “Textbook” claim that this power derives from “too much money chasing too few goods” is simplistic, misleading and out of context to the whole.

Now, if ALL increased Money Supply were loaned to consumers to purchase EXISTING Goods that would be true. But economics is NOT a static event. Price direction will be determined by the net differential resulting from the effects of all outstanding supply and demand factors. This can be clearly visualized by looking at the mechanics of jet and rocket propulsion. The term “For every reaction their is an equal and opposite reaction” is a ‘law’ of physics but does not describe the phenomena. When combustion take place in a chamber with a hole in it, there is equal pressure on all the surface of the chamber EXCEPT the hole. It is the pressure on all that surface that moves the chamber AWAY from the direction towards which the hole is facing, not the jet going out the hole.

So, a multiplicity of causes and effects are constantly in play and the resultant creates the price direction. What appears to happen is that a particular excess is observed to have taken place and is then assigned as the “Cause : of some phenomena that is synonymous to the excess. A perfect example is Mundell’s claim that European money flooding into our stock market created our economic boom. (European’s ‘invested “purchasing rights” are transferred to American stockhlders to spend.) Now, he may have concluded that without that inflow we wouldn’t have had the boom but the boom was a result of the summation of ‘all’ the factors. It was also created by the !00-125% mortgages, but those were not ‘the’ cause either. If the Government had locked the doors of Microsoft and the economy crashed, would that have “Caused”it, or simply altered the balance enough to offset positive flows existent at that moment?

The Hyper-inflation of Germany took place in the environment of (as recently posted) “the banks extended their swollen deposits and bank notes almost entirely to small group of entrepreneurs for the most part the officers and directors of the cartels who frequently owned or controlled the banks themselves.” Also, this was a domestic , not global economy and barely recovering from WWI. In this case, there was an extreme shortage of goods and productive capability to be “chased” by the expanding money quantity.

Fast forward to today and you see acres of manufactured homes, John Deeres, Caterpillers,— Stuff! INVENTORY! Financed by debt and seeking consumers funds. We have a domestic and global PIPELINE filled with goods that can clamor for the dollars in the float. Even the exponential energy costs are mainly transferring purchasing rights from Walmart shoppers to Fuel suppliers; that is as long as every one keeps the job that enables them to service the debt.

The “Big Turkey” that can be targeted to keep Leviathan fed is the composite of holders of debt instruments. “New loans for old” may cut down on their spending but no production line shuts down unless in a market niche that is selective to that demograph..

In the above Mortgage situation the offered re-fi at a lower rate, as the early loan did also, would free up purchasing power for us and the paid-off lender would have to re-loan his funds at a lower rate of interest earnings. Given the principle is unchanged, no new money is created but we the producers are liquefied and they, the interest owners have their belts tightened

A nation of tapped out debtors, asset rich and stressed to service debt would all benefit from Hyperinflation. However, Asher’s Third Law of Ecodynamics states “Any activity that creates gain without production can empirically only benefit a minority.,” Therefore in this current endemic situation, the ratio of buying power to available goods, necessary to inflate, cannot exist.

If the food-chain necessary to sustain this behemoth falters, then — Contracted buying power, lot’s of debt, no sales, need to raise cash, nation wide garage sale; =Deflation!

Waiter: “…and for you, sir?”
Uncle Sam: “We shall have the hyperinflation.”
Waiter: “Sorry sir, we’re out of the ingredients to make it.”

Burping Leviathan
HYPERINFLATE THIS!
@ Perplexed, Turbohawg & tg

“Getting the money into the hands of the great unwashed,” requires lots of water (liquidity) and soap (low interest). Our recent foray into the “Carwash” that I referred to last month, pencils out as follows:

Two vehicles, one domestic, one foreign; were traded in for new ones. Both were similar to the old ones in price range and type (more bells and whistles) but still averaging only about 5% more for a median 4 year period. The loans had an average of a year to go to payoff with a balance due of $10,000, and the trade-in values, after negotiating and figuring in overheating- testing positive for hydro-carbons in the engine for one and multiple job-site dings on the other, totaled $17,000. After paying off the current loans that left us with a net credit of $7000. By signing some papers, no money out of pocket, we drove away with $52,000 MSRP, purchased for $46,000. Therefore after deducting the $7,000 of credit we were issued new loans totaling $39,000.

Now, the $10,000 dollars that was “destroyed” had been yielding its investors an average of 10.4% but the new $39,000 that was “Printed” is only yielding it’s suppliers %7.2. Furthermore, the old loans ran five years, and the new ones (Lease) run seven, the final four being at the lessor’s risk as we can walk away at lease end. Meanwhile, we have new upgraded vehicles, back on warranty with no threat of known and unknown multi thousand repair bills, new tires and two full tanks of gas. And along with all that savings of deferred maintenance and the comfort and luxury of the new vehicles, our net monthly payments are —–$60.00 LESS! The only ‘cost’ is what will be due after the dates the old loans would have been paid off. At that point we will have the new debt, but also newer equity. So there you have a microcosm, The money supply went up $29,000 and the cost of servicing debt went down.— It’s the future commitment that went up!

This is how Leviathan gets fed morsel by morsel. The new, cheaper money created, reimbursed Ford and Subaru for one unit produced. So far though, all this liquidity created has only resulted in giving the beast a good burp and he immediately asks for another helping.

The phenomena of msg#: 46783, 1/28/01,
>>> you see acres of manufactured homes, John Deeres, Caterpillars,— Stuff! INVENTORY! Financed by debt and seeking consumers funds. We have a domestic and global PIPELINE filled with goods that can clamor for the dollars in the float. <<< was confirmed by last week’s announcement that GM is shutting down 14 out of 26 production facilities till June or July because they “reached a crucial 100 day level of supply in the pipeline

The hard-core physical fact is that all that money washing around the inflationist’s ankles is not enough quantity to pressure the demand side of the price equation. The great millennium tool-up is still holding up Leviathan’s body weight and he is in need of more nutrients than he is receiving. These are not the ingredients for Hyperinflation Stew!
Possibly it is the high dollar that generates the import demand, driving foreign production to keep cranking out the stuff and sending it to us for the credits. Could it be that what is holding off the proclaimed “Run on the dollar” is that whatever state our economy is in, as regards it’s ability to service it’s fiat debt, we constantly stay more desirable then the Asians and Europeans and their travails.

We “Don’t have to outrun the Bear”, we just have to outrun all the others!

Even if the Government plan could restore the job count to its prior peak, the massive service of debt load that bled off consumer spending power will still be present. Added to that will be the new government debt for the stimulus. Until debt is paid off in FULL the monthly payments on most loans continues to drain consumer spending power at the same amount. Taxpayer funded spending, to the degree that it enables some of the current unemployed to spend and service debt, will at best, mitigate the downward spiral, forestall some loan default and then, only till the money runs out.

Any economic activity suffering from insufficient income, absent increased sales or reduced costs of production, must look to reduce the cost of overhead. The two forms of consumer overhead are debt service and taxes. Cutting taxes does stimulate as future after-tax earnings become higher but this will be too little, too late. Spending power evolves SLOWLY from whatever future earnings continue to be generated.

Cutting the costs of debt service generates instant purchasing power and continues for as much as thirty years. Under quantitative analysis it is by far the most powerful re-boot!

See “A Stimulus That Keeps on Stimulating” and other posts for more understanding.

Comments are encouraged: Much thinking and writing is generated by responding to the thoughts and observations of others.

This was posted in a contest titled: “AMERICANS DISCARD OLD RULES, INVEST, SPEND WITH ABANDON” (2nd place winner)

Per Pogo: “We have found the enemy and he is us.”

Martin Luther said “Give me the child, and I will give you the man!” If the child sees the old rules abandoned, he will grow to be one who plays by new rules, or by no rules. From parent to child and also from the environment the child grows up in, comes a concept of how the world works. Sadly though, his concept is usually formed encompassing a very short period of time. Long-term awareness of the workings of man are not grasped by the multitudes. “Those who forget history, (or do not learn it) are doomed to repeat it.”

The current fashion of investing and spending with abandon has occurred before, but never to such a great extent by such a large percentage of society. In this century there have been several peaks of economic ‘prosperity’. Some, such as the post-war boom of the forties were built on real production, whereas the prosperity of the Roaring Twenties and the mid-Seventies were built on ‘wealth transfer bubbles’.

Economists fail to educate people on the underlying realities, mainly because they get buried in such factors as the money supply, debt, credit and governmental control. They lose sight of fundamentals that are as immutable as the laws of gravity. The concept of wealth is not clear to contemporary society. Unrecognized is the fact that wealth is either garnered by creating product for exchange or is obtained by transference. The difference between these has become blurred beyond all recognition. That phenomenon is not new. It was the tangle Ayn Rand was trying to unravel in Francisco’s speech beginning with. “You cannot ‘make’money.”

The question, “What is money?” has been a principal topic on this Forum. I am referring here to money in the form of legal tender. The failure to understand what money is, comes in part from the failure to realize what it is not. Money is not a thing; it is a right. Specifically, a banknote is a purchasing right issued by a government. It entitles its holder to acquire goods and services. It is issued in exchange for the delivery of goods and services as earnings or in return for future delivery and interest, in the case of a loan. Or, it can be transferred from one to another via trade. It is in the activity of trade that money takes on the apparency of being a thing, a commodity to be obtained, rather than a record of production and entitlement.

What becomes lost is the reality that, regardless of how much money one or all has, the goods and services obtainable are ultimately only created by production. This is the state of a society when, to obtain money, it becomes immersed in the activity of trading rather than producing. In trade, the wealth must come from someone else. For every trader’s profit there must eventually be another trader’s loss. Even if the man in Atlanta knew this, he was a member of a society that believes that it’s the other girl who gets pregnant, the other guy who causes it, the other driver who can’t hold his liquor, and the other criminal who gets caught. Naturally, it’s the other guy who loses in the Market. But of course that’s also what the other guy thinks. If millions are made in day trading, then millions must be lost in it. Why should it surprise anyone that someone dropped $500,000, while thousands of day-traders are ‘making’ money at the same time?

In the Forties and Fifties, there were performances in schools and summer camps of a play called “The Monkey’s Paw.” It’s a story of an older couple who come to possess a talisman that will grant them three wishes. Naturally, their first wish is for a large sum of money. The next day, the constable appears at their door to inform them that their son has been killed in a violent auto accident. The insurance money is exactly the amount they wanted. Simple lesson: Money can not appear out of thin air. It must represent some past, present or future activity. Money is how man divvies’ up the quantitative production of society. That play should be part of lesson #1 in any course in economics.

(I suppose I’d better pause here and tell the other two wishes. They next wish him back to life, and he appears in the doorway, grotesquely broken and disfigured from the accident, whereupon they immediately use their last wish to send him back to the grave. There are all sorts of ways to apply this parable to the present moment, I would think. )

So how did our society arrive at this dynamic moment in economic history?

I think it got started in the inflationary investment boom of the Seventies. By that time the lack of the work ethic was being lamented. Of course, it was always “the other guy” that had the problem. A sense of entitlement had permeated the land. Others owed their work. Individuals began to see themselves as deserving more. As a larger percentage of economic product provided goods beyond the need for survival, there was a far greater amount of goods to be distributed in exchange for money obtained from others. In 18th century France, this activity also resulted in the production of guillotines.

In the mid seventies, we were visiting relatives in the Bay Area. They were engaging in the popular and lucrative activity of buying a home, renting it out to cover the payments and then shortly thereafter selling it at a substantial profit. We were still immersed in the 60′s philosophy – working with our hands and producing real product for our money. Still guilty of the youthful sin of lecturing our elders, we admonished them about the lack of morality in their activity. They, being environmentally and socially conscious Berkeleyites, agreed with the truth of what we were saying, but they asked us, “What should we do, just watch it go by?”

Well, watching it go by was not what anyone was doing. The typical talk at social gatherings became various versions of “Buy something that appreciates, on credit, and pay it back with cheaper dollars.” When the flow of discretionary capital into tangibles triggered exorbitant interest rates, money moved back into banks and bonds. Just as, once a tiger gets a taste of human flesh, he becomes a man eater, the taste had been awakened for the hip and savvy investor to trade for money.

Simultaneous with the development of the nonproductive reward phenomena was the growth of the viewpoint, “I am the center of the universe.” It started in the early fifties when psychiatrists blamed the actions of criminals on their unhappy childhoods. Then several decades of the Me generation came along, and at the same time children were being raised to perceive the world as what they saw on television. Art became life, and affluence became what the smart obtained at the expense of the foolish. Marriage became something that failed because your mate did not live up to your entitled expectations. No one was any longer responsible for anything that happened to them.

The final nails that would be used for the coffins of the Columbine students and the Atlanta brokers were forged by the expansion of the “Your Fault” syndrome into the courtrooms of the land. No longer was it just “Sue the bastards!” It was, “Sue the money-owners!” If no one is responsible for what happens to themselves, than obviously someone else is.

This year in schools and brokerage houses, two insane viewpoints converged. Esteem and wealth are not earned. You are owed them. If people do not deliver what they owe you, than you make them pay.

The zenith of the monetary excess is also upon us. It is certain that the Atlanta event has focused attention on the mechanics of the unearned money game. Part of this week’s market decline, I’m sure, can be attributed to the element of sobriety induced by that event. But that is just helping to bring the inevitable to an earlier conclusion.

“Invest and spend;” that’s exactly what this Market and the economy is composed off. The books of the economy have a gigantic double entry. Investors ‘save’ their money in stocks, but in reality that money is the spending money that has already fueled the great economic boom. The money appears in the bank accounts of the stock sellers, while being perceived as being ‘owned’ by the stock buyers. A basic law of economics could be written. “One dollar cannot occupy two pockets at the same time.”

Legal tender is a receipt for goods not yet delivered. The delivery is, of course dependent on faith that banknotes will remain the agreed-upon form for recording production rights.

The securities and recorded credits around the globe have increased in declared value, to far more product than has been created. Transferring wealth between nations, mega-entities and individuals, has blind-sided most people to the quantitative truth of the global economic wealth. That being that an unprecedented percentage of it is a derived future promise (i.e. derivative.) Paper’s unsustainable promissory commitment and the unsustainable economic boom created by just-in-time production are shortly going to result in a lot of broken promises. Stocks, bonds and other securities, are promises of money. Bank notes are a present time via for money. But for absolute, guaranteed money, there is only Gold.

Gold has been disfavored in terms of the legal tender of the world, but that does not negate its senior value. Using and abusing gold for the purpose of profiting on it as a trading vehicle has altered people’s perception of its intrinsic value.

In the final analysis, is or isn’t, is far more important than large or small! In terms of liquid assets, when the game of financial musical chairs comes to its next halt, the only seats in the house may be those made of Gold

The Prime Enabler — Ponzzi Paper — Written in 2000

Money can’t be “Printed” if no-one borrows it. The three basic categories for qualification are income, collateral and credit history. The income was the easy one. A few weeks’ pay stubs or a few months’ bank statements (formerly good for only high risk/interest) became the norm in lieu of two years of tax returns.

The collateral is where the miracle was performed: Paper Wealth! The phenomena of the brainwashed majority pumping their weekly and monthly savings through the stock markets, was the tide that raised all wealth boats. Also, the easy profits from the market money pump contributed to additional collateral via rising home prices. Home equity collateral was then expanded by 100-125% mortgages. This was the equivalent of the 10% stock margin leverage of the Twenties, just being collateralized with different security.

The expanding collateral loan base and easy qualifications liquefied the composite credit world so that almost anyone could subsidize income as needed by additional borrowing to service debt. All the folks “Good Credit “history then became the primary factor for loan qualification and for loan solicitation. This third factor has also applied to the whole world of credit cards, not just secured loans. Certainly, the advent of the derivative enabled all this loosening of loan qualification requirements. The thing is, a derivative itself is only as good as the ‘credit’ of its writer. If events cause the bulk of this “insurance” coverage to come due, those same events may include there being no money to pay it.

Now Steve asks “who caused it and what they stood to gain by it?” Before this last 10/12 year period, most mortgages stayed with the original lender. Suddenly, it seemed, mortgages were being sold and resold. Rather then being created for an income stream, mortgages are now most often created to be an instrument to sell at a mark-up. Declining interest rates are what makes this viable. Mortgage paper behaves as bonds do, when interest rates drop, the yield factor increases the asset value of the paper. Notice that the latest rate cuts have not spread into mortgages and other long term paper. As interest nears the bottom, the yield advantage of earlier written paper becomes less likely to hold into the future.

Meanwhile, though, the writers and subsequent sellers of mortgages are “off-the hook” as soon as the paper is out of their hands. Add to that the dominance of the market by large outfits with scores of loan agents only concerned with their commission and putting the most positive of ‘spins’ on loan applications sent to the underwriters, and you have the easiest money in history.

The conservative banker with his eye on the balance sheet has been replaced by Alfred E. Newman, the mortgage salesman saying “What; me worry!”

Allocation of Capital

Circa 1999/2000 a question was asked: “Do stock markets always allocate capital wisely?

How about first asking the question? What capital is being allocated other than that which is invested in IPO’s?

Other then the above, all stock market activity is as follows.

“A record breaking amount of discretionary income has detoured through the equity markets. Specifically, the earners of that income, instead of “saving” it or spending it on consumption or production capitalization, have decided to reimburse an owner of shares in a company. Then the seller of those shares makes the decision to consume, capitalize or spend. Ergo, money “flows through” the stock market rather then being “in” it.

—” money does not flow into “working capital.” What is lost on the multitude who think they are “Investing in a company’ is that “capital investment is only generated by the original issue of the shares and everything after that (99.99% of stock trading) is an after-market of reimbursement. While some insiders selling into the hands of the foolish public are officers of corporations holding large share positions, the majority of distribution is from speculators that are more connected and wiser than John Q. But all of this is money changing hands for the possession of corporate shares at , in most cases, prices bearing no resemblance to the intrinsic value of the ownership. —“stock shares are another one of the major currencies. —- spending stock market profits is, in effect, spending some of the investment money of the guy you sold it to. He doesn’t have it any more. It’s not “in the Market.” What is “in the Market” is what he gets when he sells it. So, in a sense, stock securities are a global currency like dollars, francs, marks and yen,” The stock market has become a ‘Money exchange’ and has become the new “Opiate of the masses.” Empirically, I would define it as “A betting pool wherein people trade equities in a competition for each other’s money.

Written 16/Jan on americansolutions.com. in answer to comments that were questioning these observations.

One more time on “Zero Sum.” Regardless of what is done with the capital, the market, at the moment of a transaction being executed, transfers purchasing power from one person to another (Minus the commission BTW) ALL that changes is what the new owner of the funds chooses to do with it. No new purchasing power has been created and the new owner of the funds was DEPENDENT on the ability and desire of the former owner of the funds to transfer them. If there are NO owners of funds willing and able to transfer them than those shares at that moment have no value! What I consider to be the SIGNIFICANCE of this is that a lot of planned expenditure is based on this technical DOUBLE ENTRY: that being that one party has the funds and the other party also perceives that he has them.

The Stimulus post lays out the mechanics of how the recession was an inevitable result of an economy built on runaway consumer credit. There is also another phenomenon in play in the form of savings that are comprised of wealth that does not really exist.

In recent decades, ownership of stocks has become more of an up or down speculative activity rather than purchasing shares for yield or appreciation tied directly to true growth. Regardless, other than IPO’s, share purchases are the cash reimbursement of ownership, not actually investing in the true sense of the word.

These trillions of dollars of wealth are actually a perception. Every dollar of stock sale receipt comes from some one else’s earnings. The share buyer’s savings becomes the seller’s spending money. It is wealth transfer; A zero sum game! It is currently coming unglued. All stock market value depends on the future expenditure of other people’s disposable earnings! As those disposable earnings disappear, The perceived purchasing power of shareholders disappears also.

The title of an award winner of mine in April of 2000 was “There’s no Such Thing as Money in the Market.”

What follows is the original post:

Peter Asher (04/13/00; 12:59:10MDT – Msg ID:28562)
Econoclast (04/13/00; 11:46:58MDT – Msg ID:28561)

Re your >>>I’ve had a thought which leads to a question…
If anybody had any opinions on this, please share. — As far as I’ve reasoned it out so far, if a share of stock that was worth $100 yesterday is only worth
$50 today. Was that $50 of lost value simply extinguished from the money supply?<<<<

None of the money supply is “in” the market to be extinguished. — I went back and edited Y2K out of a previously posted tome, itself a composite of earlier posts. Hopefully, this will clarify rather then confuse this controversial issue.

***********
All money must firstly lie in a bank ledger, a wallet, a strong box or under a mattress. All of us here have agreed with the empirical fact that money does not ‘lie’ in the stock market; even the money spent on an IPO becomes someone else’s working capital, residing in their bank account.

So there is a lot of money out there, always being ‘someone’s’ spending power unless it cycles back to the bank, reversing the fractionalization creation, or to the Fed as a repayment from the bank that originally borrowed it. Therefore the question is, who has that spending power and what might they intend to do with it?

A record breaking amount of discretionary income has detoured through the equity markets. Specifically the earners of that income have, instead of spending it on consumption, on the capitalizing of production, or ‘saving it’; decided to reimburse an owner of shares in a company and then the seller of those shares makes the decision to consume, capitalize or spend. Ergo, money “Flows thorough” the stock market rather then being “In” it.

Let us assume for now, the continuation of the present level of sales and employment and therefore the same level of discretionary income. If stock market sentiment were to decline, then the spending decisions will swing back to the income earners. In that environment, will there be more homes and new cars bought, more businesses started or expanded, or more money ‘saved’? (The latter, of course, is allowing the Banks to expand the amount of that money and then loan it out for one or the other of the former.)

An expanded money supply, demanding more goods and services from a specific quantity of production facility, would be inflationary. On the other hand, if a lot of spending power were used to hire the creation of more production facilities, it would not. Finally, if their was an excess of production facilities created, there would be deflation. Recession or depression only occurs if the cycle of produce and consume breaks down, from whatever cause.

Envision the Free market economy depicted as justice is, by a sculpture of a blindfolded lady holding a scale. One side weighs production, the other consumption. It all comes down to a question of balance.

In a falling market, the *outstanding money supply is changing hands, not changing in size*. If the stock market declines, gradually or otherwise, those who get less for their stock than they paid for it, have allowed some of their earnings to permanently stay in the hands of others.

What will be increasing when less money “cycles through the market” is the amount of spending decided by the original receivers of income, rather then when that spending decision was made by stock sellers. I believe last year I posted a concept of stock certificates being the fifth currency, after the dollar, yen, mark, and SF. Other than the right to take part in company affairs, the only difference is the form in which that (stock) currency is exchanged. That is why the wealth effect exists. People perceive their stock as a saved currency that will increase in value against the dollar.

It is not the inflated values considered to be the “Bubble” that I see as the danger. It is the magnitude of the overall investment capital that is passing through the equity conversion machine and exiting as spending money.

The challenge to AG & Co. is to keep that flow-through steady without expanding the bubble or scaring investors out of it either. It would appear that Investors fear of loss is becoming strongly counter-balanced by the fear of missing out on exorbitant capital gains. AG could be shrewdly playing this “like a violin” as they say.

One day some optimistic comment or an as expected rate announcement. A few days later, a little bit of a discouraging word. The market rallies, the market corrects. Investors are no longer ‘making’ their twenty percent. At some point they may be just breaking even. But they’ll never know if next week everything will go roaring upward again. Damned if they sell and damned if they don’t.

I’ve stated that money is a form of bookkeeping, and that a dollar is a “production chit.” So, let’s say a dollar is a note that says, “Pay to the bearer on demand one dollar worth of goods or services from the people of the USA. My point is that the government is not the writer of that note. The USG is the Title Company guaranteeing that note. The govt. doesn’t really owe it; that note is based on the American People’s ability and willingness to honor it.

As long as the citizens of this country are getting up and going to work and keeping the economic machine going, they are the primary underpinning of the US dollar. The secondary factor is how the trade value of the dollar floats in the currencies game. This massive debt that occurs from printed money represents goods and services consumed in return for goods and services not yet created. So, maybe there is a check and balance here. If global money games devalue the dollar, then the demand for American goods and services would rise, the trade balance would improve, and the debt level decrease. The threat to the global economy comes from excesses. If default or devaluation of sufficient magnitude occurs then the domino effect gets triggered.

The gist of all this is that fiat money depends on maintaining the agreements behind it. (Dun and Bradstreet’s motto is “Credit: Man’s Confidence in Man”) If the agreement can not be held in place, then a medium of exchange is necessary to hold onto value earned, and this is where GOLD has always functioned.. The big question is to what degree does one need to devote production into hoarded gold, in order to secure earnings. (That is what the central banks are wrestling with at this time. Do they back their currencies, or purchase more national necessities such as weapons, welfare or favors)

The money supply expands or contracts depending on the loaning or returning of funds, (credits) out of or into the banking system. The effect of a market crash would certainly be first and foremost a decline in spending. The “Wealth Factor”, which is nothing more than an expectation of future stock sales being paid for by money being ‘saved’ out of future earnings, would be devastated. If stock market sentiment were to decline, then the spending decisions would swing back to the income earners. In that environment, would there be more homes and new cars bought, more businesses started or expanded, or more money saved? (The latter allocation, of course, would result in the banks expanding the money supply and then issuing loans for consumption or capitalization.) However, if there wasn’t a demand for new loans due to a crash in consumer confidence, then that money would exit the Money Supply.

Years ago, people used to say” I have some stock in AT&T” or whatever company. Not “My money is in AT&T.” That’s all people have, a share in a company. The only money that is actually IN the market is whatever bid is on the floor of the exchange at that particular moment. If at noon tomorrow there are bids for 2000 shares of AMZN @ $50 per share, and nothing else, then in that moment in time, the total wealth factor of the company could be seen as $100,000. First guy to sell his 2000 shares is the one who “Gets (some of) his money out of the market.”

If that flow through of savings into stock sales diminished, spending would then depend on what money people were earning, and whether they saved it or purchased consumer goods. If they saved it in banks it would contract the money supply, If they kept it circulating, purchasing things, then the ‘price’ inflation/ deflation would depend on the willing buyer/willing seller dynamic that is the heart and soul of economics. My definition of the cause of inflation is “The power to command price.” Even if wages are not earned due to a shortage of supplies to run the production, prices can still stay up there if there is ‘saved’ money in circulation to acquire the remaining available goods. For deflation to occur there would have to be enough goods eagerly seeking a small pool of buyers who still were willing to spend. If everyone who still had unspent credit was scared into gold, it could go to the moon while everything else was in the tank.

I would define a depression as a situation where people cannot find the opportunity to produce and exchange with each other. The government can always print our way out of a depression. But then those who still have purchasing power will not have the opportunity to buy up the world for a pittance, so, the question then becomes “Who will the government be working for”

There is one cardinal difference between Gold (and silver) and bank note currency. All bank notes are credits; they will purchase things from others, but only so long as their debt is honored by the society that uses them for rights of exchange. A banknote basically a WeOU. “We the people of this country owe you this numerical value of goods or services.” (Dependent on where inflation or deflation has taken that value when you call in the entitlement.) So in a sense, when you take currency out of the bank you are saying, “Hey tear me out that piece of the page where you have my deposit written down. I’d rather hold on to it myself.” Therefore, an FRN is the last refuge of credit money. No matter what fails in the world of electronic or paper ledgers, holding your own “Ledger to go” as Aragorn then described this, is a safe solution.

What cash has in common with gold is possession at the expense of lost interest. The big difference is that only gold protects against lost value. Gold or silver or precious stones are in effect, credits exercised and transformed into the ownership of portable value. That value may fluctuate as does a currency, but it can not be defaulted. In post #2400 of 2/14-PM, I defined Gold as ‘asset’ money and currency as ‘credit’ money; I keep coming back to that as the basic criteria for analyzing the relationship between gold and paper.

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By Peter Asher©

Originally posted on American Solutions, 8 Dec. ’08

“No one saw this coming.” — Dick Cheney

“My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today”– Robert Rubin

How absurd!

Anyone with an analytical mind could have seen it coming and anyone with an analytical mind can be shown what needs to happen to fix things.

This recession was not caused by a credit crunch and it was not caused by the sub-prime crisis. The cause was that the economy was built on a debt bubble that expanded to a level of unsustainable debt service. The capability to produce goods and services expanded to the money supply allotted to it, but an economy that attains equilibrium on the advancement of purchasing power must inevitably contract when that advancement can no longer be maintained. . Defaulting mortgage debt was the proverbial last-straw-on-the-camel’s-back, the final load on this unsustainable debt.

Debt service now claims a substantial portion of overall purchasing power. The portion remaining to drive the economy is therefore now less than it would be even on a no-credit, spend-it-as-you-earn-it basis. The economy that has expanded to fulfill the demand of earnings-plus-advanced-payment, must contract to the demand of earnings-minus-cost-of-debt-service. What for decades was an economy built on, “Buy now, pay later,” has become, “Pay now, buy later!”

Statistics on sales, from lattes to car purchases, indicate that, as with the stimulus package, people are curtailing spending and are saving or paying debt with earnings. Yet one person’s earnings are created by another person’s spending. One person’s spending enables someone else to earn a living, as someone else’s spending has enabled them. What creates the imbalance in the economy is spending what one has not yet earned on that which will not contribute to earnings.

This is the difference between money borrowed to facilitate production and distribution and money borrowed for consumption and speculation. In between, there is borrowing for personal needs that are essential for personal function, such as a car loan or a new computer. Credit abuse, not credit use, is what damages an economy.

Now, as the numbers of the unemployed swell, more unemployment is triggered because those former wage earners no longer have the spending power to contribute to other people’s earnings. This is feeding on itself and is potentially a downward spiral headed toward a full blown depression.

The bailout devotees claim that frozen credit markets are holding this recession in place. Infusing hundreds of billions of dollars into the banking system was supposed to result in making new credit available (which has not occurred), and yet it is the extent of credit already granted that has brought about the situation in the first place. More credit, which can only be issued to the degree that there are those who can still qualify for it, can provide a temporary stimulus, but after that there is that much more debt load to be serviced.

The proportion of purchasing power created by credit relative to the total economy is far greater than at any other time in history, a direct result of qualification standards being lowered more than at any other time in history.

The housing bubble was really a replay of the 10% margin phenomena that created the 1929 stock market bubble. Highly leveraged purchases of equities that have been highly overvalued by, let’s call it, mob psychology! People do not so much forget history; they seem not to have learned it. I doubt there was a single money-losing home flipper who knew of the Dutch tulip bulb mania which escalated to the point where someone sold their town house to purchase one allegedly exotic specimen!

All of the bailout proposals, including the tax holiday, create new debt. There is no quantitative difference between giving consumers more credit directly or causing them to be indebted by the taxes that will come due to finance stimuli. The only difference between a tax holiday and government-issued checks is the method and apportionment of the distribution.

The one stimulus that would create new purchasing power without creating new debt would be the refinancing of existing debt at lower interest! Paulson has proposed this as a possible 4.5% interest mortgage rate, but that has been acknowledged as only available to those individuals qualified under the current strict lending standards.

Someone rolling over a $300K mortgage from 6.5% to 4.5% would be “stimulated” by a reduction in debt load of $500 per month/$6000 per year for decades. That would be a much more powerful stimulus than a single government check for $1200 or even a two-month tax holiday that would save an average of maybe $4000, one time only. Also, while Government stimuli empirically result in additional taxes, reduced mortgage payments would immediately result in reduced interest deductions, whereby tax revenues would increase. Unfortunately, the number of people who would be able to obtain these possible refi’s is nowhere near enough to generate the purchasing power necessary to give the required “jolt” to the collapsed economy.

Currently America’s internal and external debt is about $60 trillion, almost 500% of the country’s annual GDP of a bit over $14 trillion. Of that total, family debt (including mortgages) is about $15 trillion, financial firms $17 trillion, non-financial firms $22 trillion, municipal debt $3.5 trillion, and national debt $11 trillion.
Leaving aside the fact that all of that debt must be paid back from the flows of personal and business earnings; the $15 trillion family debt, if owed by – say – 60 million households, averages out to $250,000 each.

If mortgages are running 6% to 11% and credit cards up past 30%, we could, for the purpose of discussion, estimate the median interest rate to be 7.5%. This comes out to $1562.50 per month for that average family. That’s $1,125 trillion of interest per year, which is 8% of the GDP. If that interest could be cut in half it would stimulate the economy by a growth factor of 4%!

Now rollover loans at 3.75% might seem extraordinarily low, but if the Fed rate were held long term at ½% to zero, then that lower interest rate could be brought about. If the lenders weren’t willing to do that, perhaps some “Jawboning” or direct stipulation from their TARP benefactors would do it. The newest plan to adjust mortgages in bankruptcy proceedings is short sighted! If mortgages are adjusted by refinancing now then people don’t wind up filing for bankruptcy.

Failing that, the government could bypass the banks and create a direct-from-the-Fed lending entity to give one-time rollover loans to all who were fully current on their debt, as of the first of the year. The loans could refinance both mortgage (home owner only!) and credit card debt. In return, the debtor would agree to a stipulation (recorded on their credit report) that they were unqualified for further credit until some time well-off in the future when they would have significantly reduced their debt. Not only would this reduce the cost of the systemic debt overload it would be unwinding the systemic debt position.

Those that lost their jobs or had major business setbacks could be given a year’s grace by amortizing a year’s interest into the loan which would only raise the interest rate to 3.9%. This would allow them to keep their homes, which would greatly enhance their ability to focus their energies on reestablishing earnings. Simultaneously the economy would be recovering sufficiently to provide the opportunities needed.

This Fed-direct plan would initially require new funding into the system, but every loan paid off would route those funds to the banks or the holders of credit card and mortgage bonds. The banks, having their customer base reduced by the competing loan rollovers, would have excess capital inventory. Money “printed” for the fractionalization expansion could be required to be funded back to the Fed. The bond holders would have their bad and risky loans paid off, be recapitalized, and have new funds to lend. Their “mark to market rate” would recover. There would no longer be a need for a bailout; it would have been done in reverse order!

Naturally many loans would not be fully collateralized, but collateral value would immediately rise upon the implementation of the program, since foreclosures would not be glutting the market and qualified buyers would be re-establishing activity in the home construction sector.

Certainly, the banks and credit card companies would strongly object to a plan that would severely contract their business However; if one can grasp the magnitude of the threat of debt, default, deflation and depression; one can see that surviving at a smaller size is preferable to being larger and defunct!

All of the above, aided by a re-institution of usury laws, could lead to an economy and a society that are less dependent on spending not-yet-earned money for the needs of the present moment.