Mario Draghi Speaks to An Empty House – What Crisis?

It is quite amazing how secure the eurocrats apparently feel about their positions. In what must be called a damning indictment of the European parliament, almost no MEP's were present when ECB president Mario Draghi delivered his address to the house yesterday. He might as well have stayed home. You'd never know there was a crisis going on, considering the deserted house.

As the WSJ reports:


A rough leaning-over-the-balcony headcount gave 35 MEPs out of 736, as per the attached photo (Draghi is just to the right of the blue lectern in the centre, sitting in the front row).

At least some of them were kind enough apologize to Mr. Draghi for the appalling turnout, including the French ALDE member Sylvie Goulard, who politely lamented that so few of her colleagues were present, and from the other end of the political spectrum, the UK Independence Party’s Godfrey Bloom.

“Thank you for turning up, even if no-one else has,” said the outspoken representative for Yorkshire, etc.

 

(emphasis added)

This is the photo in question:

 


 

The Euorpean parliament on the occasion of ECB president Mario Draghi's address yesterday: he spoke to a completely deserted house. What crisis?

(Photo credit: Frances Robinson)



 

Nevertheless, Draghi's speech contained a number of interesting hints that once again confirm to our mind that the ECB is getting ready to increase its pace of monetary pumping. With money supply declining in all the PIIGS (see e.g. the below chart of Italy's monetary contraction), the ECB certainly has the excuse that it needs to combat an incipient deflation.

 


 

The growth rates of Italy's money gauges M1, M2 and  M3 have all declined sharply since the 2009 peak and entered slightly negative territory in 2010. This is mainly due to the ECB not adding to its initial 'emergency liquidity' provisions following the 2008 crisis – click for better resolution.

 


 

Here are the essential points from Draghi's speech according to a report  by Reuters:


„European Central Bank President Mario Draghi signalled it was willing to take further action to prop up the euro zone economy in a speech to the EU parliament on Thursday, saying risks had grown and that the ECB was aware of growing banking problems.

Highlighting action the ECB took on Wednesday with other major central banks to provide dollar liquidity that was reminiscent of the 2008 financial crisis, Draghi said the bank would ensure inflation did not undershoot its target as well as exceed it.

Markets read that and the warning of growing downside risks to the economic outlook as pointing to a second cut in official interest rates in as many months at next week's ECB policy meeting, pushing the euro to a session low.

"The ECB's monetary policy is constantly guided by the goal of maintaining price stability in the euro area over the medium term — and this applies to price stability in both directions," Draghi said. "Downside risks to the economic outlook have increased."

Draghi stressed that he was speaking in the ECB's pre-meeting period and that nothing he said should be interpreted in terms of future policy decisions.

But many investors read the comments as upping the chances for a rate cut next week over which analysts have been divided.“

 

(emphasis added)

It is quite amazing that Draghi refers to an 'undershooting' of the ECB's 'price level target' even as the rate of growth of said price level measure resides a full 50% above the informal target and at a multi-year high. However, it is of course true that euro area money supply growth continues to be weak.

Some analysts commented along the lines we have mentioned in previous articles – namely regarding the likelihood that the economic assessments prepared by the ECB's staff will provide the central bank with the necessary fig  leaf to announce further easing measures:


„These comments do open up the chance for a rate cut," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"Next week we will have the ECB staff forecasts and we will surely get a substantial downgrade to growth and inflation forecasts. All of which will lead to expectations of a rate cut by the ECB and extention of non-standard measures. The markets will be very frustrated if they dont get that next week.“

 

(emphasis added)

We believe one of the 'non-standard measures' that will likely be announced is the  lengthening of the terms of the 'emergency liquidity provisions' – which may take the form of either outright 24 to 36 month long repos or a firm commitment to roll over the existing LTRO's (long term refinancing operations) two or three times. Moreover, we expect another rate cut and it also seems likely that there will be another 'QE Lite' type permanent monetization operation similar to the purchase of € 50 billion in covered bonds announced at the last meeting of the governing council.

The first point shows how 'temporary' emergency liquidity provisions inevitably become  permanent – the money supply inflation of 2008-2009 will likely never be taken back. The same fate awaits all additional inflationary measures to be undertaken. The period 2010-2011 has seen the biggest slowdown in the rate of growth of the euro area's true money supply since the currency was introduced. The current crisis is a direct result of this slowdown in money supply growth: the inflationary system can not avoid a crisis unless it continues to inflate at a reasonably strong pace. The 2008 'GFC' was also preceded by a sharp slowdown in money supply growth both in the US and Europe. It is notable in this context that nowadays a mere slowing in the pace of money supply growth is all that is required to bring the system to the point of crisis.

All of this is of course a strong argument in favor of abandoning the inflationary system altogether. The threat of deflation now perceived by Draghi and others could not possibly exist if there had not been a massive inflation first.

Draghi then noted that the ECB remains supportive of the push toward fiscal integration and centralization – reading between the lines, he delivered a hint that the ECB would be prepared to intervene more forcefully if it is satisfied with the result of the upcoming summit:


„As European policymakers move into what one senior official has said are a crucial 10 days in which they can save the euro, Draghi appealed for a "comprehensive deepening" of fiscal ties.

"What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made," he said.

"We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility. Other elements might follow, but the sequencing matters.“

 

(emphasis added)

The 'other elements' will  of course consist of some sort of intervention by the ECB.  Austria's finance minister Maria Fekter also dropped such a hint at the recent meeting of euro-group finance ministers, according to a Bloomberg report:


„European finance ministers discussed the issue of the Frankfurt- based bank’s ability to buy bonds at the “margins” of a meeting in Brussels yesterday.

“There is a discussion on how the ECB can be better enabled to buy bonds,” said Austrian Finance Minister Maria Fekter, whose country along with Germany has been one of the main opponents of a greater role for the ECB.

The ECB has resisted calls to become a lender of last resort, saying its mandate prevents the bank from propping up irresponsible government spending.“


Well, judging from their reaction,  the markets evidently got the hints.

 

Banking Crisis and Sovereign Debt Crisis – Two Faces of the Same Coin

There can also be no doubt that the ECB is well aware of the enormous funding pressures that banks and governments both are facing in 2012. The numbers involved are truly staggering. As Bloomberg reports:


Europe’s banks will compete with their governments to borrow $2 trillion next year as the two groups refinance maturing bonds and bills.

Euro-area governments have to repay more than 1.1 trillion euros ($1.5 trillion) of long- and short-term debt in 2012, with about 519 billion euros of Italian, French and German debt maturing in the first half alone, data compiled by Bloomberg show. European banks have about $665 billion of debt coming due in the first six months, with a further $370 billion by the end of the year, according to Citigroup Inc., based on Dealogic data.

“Serious investors are fleeing from both European sovereign and European bank debt in droves,” said Mark Grant, a managing director at Southwest Securities Inc. in Fort Lauderdale, Florida. “The financials of both classes are in question, and nothing of substance has been achieved to correct the problems and quell the European crisis.”

The yield premium investors demand to hold bank bonds rather than benchmark government debt has soared to 448 basis points, the most since January 2009, according to Bank of America Merrill Lynch’s EUR Corporates, Banking Index. The average spread between January 2005 and January 2007 — before the crisis struck — was 38 basis points, the data show.

Banks need to refinance bonds at an average rate of $230 billion every three months in 2012, assuming they weren’t able to pre-fund those liabilities in the first half of this year, according to Lisa Hintz at Moody’s Corp. in New York. That compares with a $132 billion average for the 11 quarters ended in Sept. 30, she said.

“In unsecured funding, banks are effectively competing with the sovereigns,” said Hintz. “Just looking at a bank’s business model, what kind of profitable loan can an Italian or Spanish bank make when their marginal funding is at a spread to the sovereign and the sovereign is at 7 percent or more?”


That's a good question. The entire article is well worth reading, but the summary at the end makes a number of especially important and pertinent points:


„“The fact that central banks saw the need for such measures confirms how serious the bank funding situation is,” said Gary Jenkins, head of fixed income at Evolution Securities Ltd. in London. “It does not alter the underlying problem with European sovereign debt on banks’ balance sheets.”

A measure of banks’ reluctance to lend to one another for three months, the Euribor-OIS spread, has reached a 2 1/2-year high. The difference between the three-month borrowing benchmark and overnight indexed swaps increased to 99.6 basis points yesterday, the widest since March 2009.

Banks, concerned about each others’ credit, also prefer to put their spare cash with the European Central Bank than lend it, depositing 304 billion euros with the Frankfurt-based ECB as of Nov. 30, close to the most since June 2010.

“Central banks are supplying liquidity that the banks need,” said James Ferguson, a strategist at Arbuthnot Securities Ltd. in London. “At the same time, the banks are shedding risk assets and buying short-term government debt. So the government is providing liquidity to the banks and the banks are funding the government and so the circle continues.”

That’s at odds with rules instituted by the Basel Committee of supervisors, which require banks to fund long-term assets from long-term funding. If the European banks that fall short all tried to meet that requirement only by issuing long-term debt, banks’ need for additional long-term funding may be as much as 2.7 trillion euros, Oliver Wyman estimates.

“The sovereign-debt crisis is a banking crisis,” said Bill O’Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch Wealth Management. “You cannot unweave the two.”


The remarks we have highlighted above are of course points we have made for many months. The banking solvency crisis and the sovereign bond crisis are closely interlinked. Governments have accorded banks the privilege of fractional reserve banking with the explicit aim of profiting from what is essentially a fraudulent business practice. The vast expansion of the State witnessed in the 20th century would have been impossible without it. However, the clever boys who came up with this scheme overlooked an essential point: namely that it is not possible to suspend economic laws. The bigger the credit expansion became, the more capital consumption it engendered. There is a limit to how far the Potemkin village of false prosperity created by the expansion of the credit and money supply ex nihilo can be taken. At some point a threshold is inevitably crossed, when real economic activity has been weakened so much that it can no longer support the mountain of unsound debt.

In light of this, all the plans to further expand the ECB's monetary pumping measures can only delay the inevitable end game and make it even worse. There will be jubilation in the current economic mainstream once the ECB deploys the full force of its printing press, but this only confirms the extent to which the economics profession has become little more than a handmaiden for  the statism that the current financial system provides the basis for. The belief that systemic insolvency can be repaired with the printing press is sorely mistaken. There may be short term relief, we don't deny that – but at the price of an even bigger crisis down the road.

 


 

3 month euro FRA-OIS spread (today's value: 82.50), a measure of interbank funding stress – click for better resolution.

 


 

Kyle Bass On the Insolvency of Sovereigns

The hedge fund run by Kyle Bass, Hayman Capital Management, has just published its latest letter to investors and as always it is a refreshing – if somewhat depressing – read.

The entire letter can be seen at Scribd.

Not surprisingly, we largely agree with the analysis presented by Kyle Bass. He notes that looking at selected interest rate charts of euro area sovereigns, one must conclude that the currency union has de facto already broken up.  This may be a bit of an exaggeration, but clearly there is a very good chance that some of the peripheral economies will eventually leave the currency union. Moreover, it is clear that quite a few governments are simply bust.

 


 

From the Hayman presentation – the Greek two year note yield, long term (last data point: November 30) – click for better resolution.

 


 

Portugal's  2 year note yield as of November 30 – click for better resolution.

 


 

Bass discusses the 'mirage of the EFSF and IMF bailout' and wonders whether the ECB 'will print before or after the defaults'. He thinks it will only happen after various euro- area governments have defaulted, including that of 'too big to bail' Italy.

We happen to disagree on this particular point. To our mind, the willingness of the eurocracy to preserve the currency union by all means available should not be underestimated. Yes, there are considerable fault lines and Germany is unwilling to pay for the sins of its neighbors. However, as can be seen by recent developments, there is probably a compromise on its way, whereby Germany gets to see more fiscal control implemented in exchange for relenting on 'temporary emergency measures' that will no doubt involve the ECB's printing press. Since a default of Italy would make the insolvency of the euro area's banking system an undeniable fact that could no longer be swept under the rug by any means whatsoever, we are assuming that a rescue of Italy is very high on the agenda. Meanwhile, the new 'technocratic' government of Mario Monti can be expected to deliver an austere enough budget to remove any objections regarding Italy's willingness to submit to the emerging more stringent fiscal regime of the euro area.

Bass finally notes that Japan's government finds itself in a similarly intractable debt trap as the European sovereigns. He expects Japan to eventually become front page news as well, something that we would note is likely to be accelerated by the government going on its forth additional (in addition to its 'normal' deficit that is) spending spree this year in the form of an 'extra budget' that has just been announced.

 

The 'Balance Sheet Recession' and What it Really Means

Richard Koo, who in spite of the evidence of the utter failure of Japan's two decades long deficit spending spree continues to maintain that 'stimulus spending' is the only way to combat what he refers to as a 'balance sheet recession' has not been chastened in the least by the euro area's sovereign debt crisis. He completely ignores that 'fiscal stimulus' is kind of hard to implement once a government is completely bankrupt. Consider this brief excerpt from his most recent analysis of the euro area crisis:


“Regarding the Maastricht Treaty, the concept of balance sheet recessions was unknown in Europe when the unified currency was adopted. That is why fiscal stimulus, which is essential during a balance sheet recession, is considered a violation of the treaty.

Regarding capital flow, government bond yields ordinarily fall during a balance sheet recession. But they have risen instead because of the specific type of capital flow occurring in the eurozone, which prevents governments from delivering the fiscal stimulus that would in any case have been difficult under the Maastricht Treaty.


So it is not bankruptcy that has thrown a monkey wrench into deficit spending until the cows come home, it is the Maastricht treaty! The 'peculiar capital flows' situation that Koo bemoans consists of the fact that European savers 'can buy the bonds of the safest issuer' (namely Germany), which means that bond yields elsewhere are free to reflect the risk the finances of these governments represent. Naturally Koo also calls for massive bond buying by the ECB, which 'will not spark inflation' in his view (this is to say, it won't lead to rising final goods prices, unless of course, it does).  To this it should be noted that while the BoJ has engaged in several 'QE' sprees, it has all in all been rather tight – Japan's true money supply growth is among the lowest in the industrialized world over the past two decades. While Koo insists that the ECB could 'buy quite a lot' of bonds in unsterilized fashion without sparking rising prices (it should be clear that inflation as such, namely the growth of the money supply, would increase by leaps and bounds), he seems not to dwell on the experience of the 1970's when Keynesians had to endure a decade of embarrassment as 'stagflation' struck. The only thing that seems to count for Koo are the most recent empirical historical data, as though economic laws could be fashioned from them. It should be clear that once Kyle Bass is proven right, Richard Koo will have some explaining to do.

Let us now briefly try to elucidate what the true nature of the so-called 'balance sheet recession' is. The manner in which Koo uses the term is just as a replacement term for the Keynesian concept of the 'liquidity trap'. This becomes obvious when we consider his assertion that excessive government deficit spending not only doesn't pose a problem, but is actually necessary to counter the bust and the 'propensity of the private sector to increase savings'. 

The term 'balance sheet recession' as such is actually serviceable, in the sense that what happens when governments and their central banks accommodate a series of credit booms (again, in the fashion supported by both Keynesians and monetarists to counter recessions), is that they ultimately ruin the balance sheets of one sector of the economy after another. Once the number of private sector economic actors with ruined balance sheets exceeds a certain threshold, a banking crisis usually follows, which these days tends to leads to some sort of bail-out orgy like the ones we have witnessed in Japan and lately following the 2008 GFC. Then the penultimate stage of the process is reached, as now it is the balance sheet of the government that is being ruined. It is the 'penultimate stage' only because at that point, the ideas expounded by Georg Friedrich Knapp's Chartalism tend to come to the fore. Knapp and his followers hold that the government is not 'revenue constrained', since it can simply let its central bank fire up the printing press. So a crisis that has been the end result of decades of money printing can allegedly be solved by printing even more money from thin air.  Insolvency can supposedly be 'wished away' by the expedient of using the printing press (or its electronic equivalent).

This misunderstands the workings of the economy on a fundamental level.  The losses produced by the capital malinvestments of the boom are not just numbers in a ledger. They are very real. Once a boom falters, there are usually a plethora of specific capital goods that can no longer be profitably employed, either due to a lack of complementary capital and/or due to the simple fact that the expected consumer demand on which their employment was based has not appeared. The entire production structure that was built up in the branches to which these capital goods belong is faced with the fact that numerous investments have failed and must be liquidated. Scarce capital has been wasted. The question is not one of there not being enough money. Adding to the money supply can not alter these real losses.

Moreover, the idea that the allocation of capital should be transferred to bureaucrats via deficit spending when the private sector, faced with the losses produced by the boom, decides to rebuild its savings, overlooks that the government possesses no resources of its own. It has to appropriate resources from their current private owners and then must presumably allocate them in a more efficient manner than the private sector would. It should be obvious that in this manner, ever more scarce capital is going to be wasted. Whether the government appropriates resources by raising taxation or by borrowing makes essentially no difference, as the citizenry will regard a rise in government debt as deferred taxation and hence will increase its precautionary saving and will remain reluctant to commit to new investment.

If government debt is at some point monetized on a grand scale, there will eventually also come a point when the demand for money is overwhelmed by the increase in its supply. The supporters of money printing, such as e.g. Ambrose Evans-Pritchard, who has just penned another screed calling for ECB intervention, seem oblivious to this fact. Even if they are not au fait with economic theory, they should at least not pretend that Weimar never happened. After all, what is the central bank supposed to do when the effects of its intervention wear off, as they invariably do? Why, print more of course – until the bitter end, one presumes.

In addition, these ex-post rationalizations (which basically assert that 'now that we're in crisis we have to do what normally would be an error') always avoid discussing why we have arrived at the point of crisis in the first place. It was after all the credit expansion of the fractionally reserved and central bank-backstopped banking system that has been the root cause of the boom and bust. It is not enough to just say that the euro has 'design flaws' (even though that is quite correct). Its major design flaw is that plaguing all modern fiat monies.

The question in the end comes always down to whether one wants to take the losses as soon as possible and begin again with a clean slate, or whether one wants to delay the day of reckoning by doing again – and usually on a bigger scale – what has led to the crisis in the first place.  The choice is always between short term pain in exchange for long term gain or the avoidance of short term pain in exchange for long term misery. Why everyone seems to favor taking the path to long term misery remains a mystery to us. As we keep saying, the focus, especially in Europe, should be on how to revive the currently taxed-and-regulated-to-death entrepreneurial spirit. In the end, only a resumption of genuine wealth creation can solve the economic problems of the region. This requires that the market economy be freed to do what it does best. Printing more money is not going to help this process.

 

 

 

 

Charts by: Bloomberg, Bank of Italy, Hayman

 


 


 

 

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17 Responses to “The ECB and ‘Balance Sheet Recessions’”

  • neophyte:

    Peter –
    Been following your blog since about May of this year.

    Your Elliott wave count during the early summer months was exceptional, so I’m wondering if you have posted anything more current. If so, can you (or one of your followers) please point me to current count. You mentioned posting a new one during T-Day week, but I have missed it somehow.

    Thanks!

  • worldend666:

    That recent mooting of a bottom of the Greek stock market is now looking a little premature perhaps?

    As I pointed out after you wrote the article we are likely to see a return to the drachma resulting in a further stock market fall of another 60 or 70%, totaling a 97% peak-to-trough dive in the Athens Stock exchange Index.

    Now that, my friends really will be the bottom and fortunes will be made by the brave following that event.

    • Indeed – the Athens market has declined further – I did note at the time that the final phase of a bear market can bring large additional losses on a percentage basis, but it was nevertheless the time for a ‘heads up’ – just as the time to begin watching gold stocks for a potential generational low was in 1999/2000 (they also lost considerably more ground into 2001, but anyone who started buying during the final decline eventually made out like a bandit).
      There are good news for putative ‘bottom fishers’: a new Greek stock ETF begins trading on Thursday.

  • kstills:

    A must read site.

    Thank you for your continued thoughts on this issue.

  • Andrew Judd:

    I realise i will be going against the flavour of this board but it appears that some kind of recovery is beginning to take root in the USA. Not a recovery that is much good for an unskilled person who is among 16 million unemployed, but currently 35% of small firms advertising for staff are having difficulties getting people with the necessary skills. Exports are now at similar levels to 2007. There is even talk about oil self sufficiency as places like North Dakota turn into oil boom states. The US is also a major food and Agricultural machinery maker at a time of consistantly higher food prices.

    • There is a big problem in the labor market matching skills with the labor demanded. However, this is obviously not an insurmountable obstacle, it just takes time. Labor mobility is also hampered due to the housing crisis.
      The energy equation is clearly turning in a very favorable direction for the US, I agree with that. Hydraulic fracking has altered the situation considerably.
      However, as to the recent slew of better looking economic data, I would warn that this is partly the result of the accelerated depreciation allowance that runs out at the end of this year. This has once again pulled demand forward, this time for capital goods. The ratio of capital goods to consumer goods production in the US remains way out of whack.

  • Outlaw:

    “The choice is always between short term pain in exchange for long term gain or the avoidance of short term pain in exchange for long term misery. Why everyone seems to favor taking the path to long term misery remains a mystery to us.”

    I can tell you why everyone is in favor of avoiding short term pain…its because of the constant propaganda from the State and its economists that deflation, once it takes hold, is a never-ending spiral. That once prices start falling, everyone will cease spending in expectation of further price declines and the economy will totally crash.

    What these people never go on to discuss is that the deflationary spiral -does- actually end at some point, and that prices do actually reach a new equilibrium post-crash. In addition, production and consumption does get re-balanced and consumption does not actually go to zero in the deflation, because everyone must consume some minimal amount of goods and services to survive. In other words, a deflationary bust is a cycle that ends. But you wouldn’t know that listening to the State’s economists.

    The desperate desire to avoid the pain of a deflationary bust is greatly attributable to this neo-Keynesian propaganda. A lot of it is borne out of misunderstanding the experience of the Great Depression as well. Few understand that it was the huge scale of the boom, and the constant government intervention that followed it that made the Depression so protracted and “endless”.

    To our chagrin, this misunderstanding of history is dooming us all to repeating it again on an even grander scale.

    • Outlaw:

      I will also say this. I am so ashamed of humanity and Western culture in particular, that we allow an injustice on the scale of fractional reserve banking. It is truly a global system of fraud and enslavement. That the cartel of banking and government would go to such great lengths to hide it from the public is beyond the pale.

      It is difficult to live each day knowing that the major institutions which govern your life are built on systematic, legalized fraud. Particularly knowing that there is nothing I can do about it except hope that it someday collapses under the weight of its own criminality.

    • RedQueenRace:

      Exactly. Murray Rothbard made this point (contractions end) in “America’s Great Depression” by stating (paraphrasing here) that credit contractions were limited to [at most] the extent of the previous credit expansion.

      • Correct – of course the problem is that the previous credit expansion in our current case was the biggest in all of history, so the pain that will have to be endured in the short term would be commensurate to that. It will be politically very difficult to take the bitter medicine.

    • I completely agree with your assessment. My ‘it’s a mystery’ comment was a bit tongue in cheek actually.

  • Sunonmyface:

    Peter, it is so refreshing to read clear, well thought out positions. If only our political system had a different structure and leaders were rewarded for public good vs personal gain.

  • zerobs:

    Bass discusses the ‘mirage of the EFSF and IMF bailout’ and wonders whether the ECB ‘will print before or after the defaults’. He thinks it will only happen after various euro- area governments have defaulted, including that of ‘too big to bail’ Italy.

    We happen to disagree on this particular point. To our mind, the willingness of the eurocracy to preserve the currency union by all means available should not be underestimated.

    I agree with Bass. There is so much denial that it will take a failure to get a few fence-sitters to fall onto the wrong side of “doing something”. Greece is akin to Bear Stearns, Italy is akin to Lehman Brothers. Then we’ll get ridiculous bailouts instead of nationalizations/closures of the banks that are at the heart of the mess. Ultimately each EU member is concerned with saving the currency union only to the extent that it saves their individual welfare states; and that includes Germany.

    • I agree that rescuing their welfare states is what is foremost on the politicians’ mind, but there are other motives at work as well. The centralizers want to use the crisis to forge a political union, and the Germans not only think about their own welfare state, but also about their, as they see it, historical responsibility toward Europe. There are quite a few cross-currents. Greece may well end up as a sacrificial pawn though.

  • I am reading Mises’ Theory Money and Credit in order to gain perspective of what I already know in a less broad sense. It is a long book, so keeping perspective is not easy.

    As far as Koo goes, I saw his talk in 2008, thought it interesting, but could see fault. Koo seemed to think Japan had survived and put the mess behind it, when in fact what appeared to work only did so due to massive credit expansion in the rest of the world, propping its export economy. In the meantime, they ruined the balance sheet of the government. The real idea behind his theory is a back door bank bailout. Now the Japanese population is being destroyed through their policies.

    I don’t know that any of this works, if there is a strong link in the chain. Being we are watching mutually assured destruction around the world, arbitrage of values has no solid place to stand. Bernanke is getting away with his fiasco only due to the fact Europe is in such dire straits. Japan is out of credit or they would have already inflated their money to extremes.

    The first one to touch new money gains the advantage of inflation. I have known this for a long time and Mises reinforces this fact. If banks aren’t lending, then they are engaged in speculation. I believe this to be the reason everything goes down and goes up at the same time in markets. Their problem is they are dealing in intangibles and the money isn’t getting to those that would otherwise make up the bigger fool pool. Passing the trash is much more difficult. The mess wil backfire and the banks will need another bailout.

    This brings us to who controls popular economic and financial theory, the banks and government. It isn’t by chance that mainstream economists support more idiocy. Just because a fool that can’t swim jumped into the river to get to the other side and made it due to a random log floating by means his technique was supposed to work. Next time he is likely to drown. Point is the Koo theory has worked despite itself. Now the nation of Japan is bankrupt

    • In the ‘Theory of Money and Credit’ Mises first laid out his theory of the business cycle. It is an extremely valuable work to this day. Nothing that has been written on money and credit before or later can really hold a candle to it, although there are of course a number of notable contributions by Rohtbard, de Soto et al. – but Mises was the trailblazer. Note though that some of Mises’ views expressed in ‘TMC’ were later modified a bit (he came out much stronger against issuance of fiduciary media in later works, while still noting some ‘advantages’ to their issuance in TMC).

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      Junk Bond Spread Breakout The famous dead parrot is coming back to life... in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” - mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while...
  • Gold Divergences Emerge
      Bad Hair Day Produces Positive Divergences On Friday the ongoing trade dispute between the US and China was apparently escalated by a notch to the next level, at least verbally. The Trump administration announced a list of tariffs that are supposed to come into force in three week's time and China clicked back by announcing retaliatory action. In effect, the US government said: take that China, we will now really hurt our own consumers!  - and China's mandarins replied: just you wait, we...
  • Industrial Commodities vs. Gold - Precious Metals Supply and Demand
      Oil is Different Last week, we showed a graph of rising open interest in crude oil futures. From this, we inferred — incorrectly as it turns out — that the basis must be rising. Why else, we asked, would market makers carry more and more oil?   Crude oil acts differently from gold – and so do all other industrial commodities. What makes them different is that the supply of industrial commodities held in storage as a rule suffices to satisfy industrial demand only for a...
  • Chasing the Wind
      Futility with Purpose Plebeians generally ignore the tact of their economic central planners.  They care more that their meatloaf is hot and their suds are cold, than about any plans being hatched in the capital city.  Nonetheless, the central planners know an angry mob, with torches and pitchforks, are only a few empty bellies away.  Hence, they must always stay on point.   Watch for those pitchfork bearers – they can get real nasty and then heads often roll quite literally....
  • Lift-Off Not (Yet) - Precious Metals Supply and Demand
      Wrong-Way Event Last week we said something that turned out to be prescient:   This is not an environment for a Lift Off Event.   An unfortunate technical mishap interrupted the latest moon-flight of the gold rocket. Fear not true believers, a few positive tracks were left behind. [PT]   The price of gold didn’t move much Mon-Thu last week, though the price of silver did seem to be blasting off. Then on Friday, it reversed hard. We will provide a forensic...
  • Merger Mania and the Kings of Debt
      Another Early Warning Siren Goes Off Our friend Jonathan Tepper of research house Variant Perception (check out their blog to see some of their excellent work) recently pointed out to us that the volume of mergers and acquisitions has increased rather noticeably lately. Some color on this was provided in an article published by Reuters in late May, “Global M&A hits record $2 trillion in the year to date”, which inter alia contained the following chart illustrating the...
  • Cryptocurrency Technicals – Navigating the Bear Market
      A Purely Technical Market Long time readers may recall that we regard Bitcoin and other liquid big cap cryptocurrencies as secondary media of exchange from a monetary theory perspective for the time being. The wave of speculative demand that has propelled them to astonishing heights was triggered by market participants realizing that they have the potential to become money. The process of achieving more widespread adoption of these currencies as a means of payment and establishing...
  • The Fed's “Inflation Target” is Impoverishing American Workers
      Redefined Terms and Absurd Targets At one time, the Federal Reserve's sole mandate was to maintain stable prices and to “fight inflation.”  To the Fed, the financial press, and most everyone else “inflation” means rising prices instead of its original and true definition as an increase in the money supply.  Rising prices are a consequence – a very painful consequence – of money printing.   Fed Chair Jerome Powell apparently does not see the pernicious effects...
  • A Walk on the Wild Side
      A Walk on the Wild Side   “Never play cards with a man called Doc.  Never eat at a place called Mom’s.  Never sleep with a woman whose troubles are worse than your own.” – Nelson Algren, A Walk on the Wild Side   Fresh Fruit or Rotting Vegetables? A subtle gas seems to always be vented into the atmosphere at the sunset of an extended bull market.  As the light fades, an odor that’s indiscernible from that of fresh fruit or rotting vegetables wafts down...

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THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

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