Sunday, March 8, 2009

Central Banks Have Lost Control

...That is, if you ever believed they had control in the first place.

Which of course they didn't. But recent actions around the world are proving, without a doubt, that this band of ideologues has no idea why none of their previous actions have worked. They've now resolved to spraying bullets like an alien-killing spaceship in an arcade game. (think Space Invaders)

As anyone who has played Space Invaders knows, bullets are infinite, so all one has to do is press the buttons as fast and furiously as possible in hopes that you'll kill the ugly bastards.

Unfortunately, when it comes to economic stimulus in a credit based monetary system, bullets are not infinite. So monetary policy is more like Duck Hunt.

Perhaps such an explanation would prove beneficial for the peanut-brains in our central banks. Considering they have disregarded any intellectual opposition to their policies, I'm not sure what else is left.

To be honest, I've kind of stopped listening to news reports about the incessant bailouts and growing programs being devised to rob regular people of their money in favour of the banking elite. Essentially, I got "bailout-fatigue." I noticed this the other day, when I saw that the government had given AIG yet another $30 Billion dollars of taxpayer money. I didn't even really react. I just kind of thought, "hmm, what should I have for lunch today?" Recall that only about 18 months ago we learned of the Bear Stearns hedge fund blow ups that totaled $6 Billion. That was the unofficial kickoff to this crisis. And now an amount 5x that size no longer even registers as newsworthy.

Does anyone else see how absolutely insane this is? Have we lost all perspective?

Then again, perhaps that was the plan all along. To bleed us dry by confusing us with large numbers.

Let's take a step back and look at what has been done, in aggregate, since the beginning of the crisis.

The New York Times has done a decent job of adding things up on this page. They conclude that the Federal Reserve and various branches of government have committed nearly $9 Trillion Dollars. Of that, $2 Trillion has been spent, and essentially kissed goodbye. The rest is 'waiting to be deployed' or has been already committed to insure or swap assets elsewhere. Note that none of this takes into account any of Obama's economic stimulus money or any of the same from Bush. And that is just the US. The rest of the world combined has probably pitched in a similar amount in the form of guarantees and direct asset purchases.

It all begs the question: "Why isn't it working?"

Well, that is something that I have written about for over a year on this blog and elsewhere. Simply put, the cancer is bigger than the patient.

Here are some quick facts (all of which are debatable depending on how they're calculated, btw):

- Total World GDP: ~60 Trillion
- Total World Equity Markets: ~30 Trillion
- Total World Real Estate: ~70 Trillion
- Total Exchange Traded Derivatives: ~75 Trillion
- Total OTC Derivatives: ~700 Trillion

How can that be possible? How can there be multiples more in electronic gambling contracts floating around than the size of the entire economy and all it's wealth combined? It's not possible. Yet a decade of economic growth was just that: Impossible.

I have no problem with derivatives. I think that they can serve a good purpose. But making bets on the direction of corn prices and making a bet on the direction of another derivative are two separate matters. That is what was allowed to occur. Contracts were piled onto contracts every step of the way, creating a web of contracts nominally valued far larger than what they were originally designed to insure against. This was never seen to be a problem by our genius central bankers, who simply scoffed at the numbers saying that much of it was "self-canceling," and therefore not a big deal.

Well it has become a big deal. Because one or both halves of the "self" that these instruments were supposedly going to cancel with whenever they expired is no longer in existence (Lehman), or is perceived as susceptible to disappearing like the aforementioned. Therefore the total value of this contract is drastically lower than what it is valued at on the balance sheet (or off).

Additionally, there has been a great deal of what would otherwise be known as 'insurance fraud' going on in the derivatives markets. That is, people have been insuring against instruments which they don't even own. This is like buying an insurance contract on your neighbour's house and hoping it burns down. It defies logic. But it has been rampant.

What this explosion in nominal derivatives did, prior to the collapse, was to instill a false sense of safety in the markets. Everybody had insurance against what their models told them were potentially dangerous outcomes to their balance sheet. With the insurance, they felt confident to buy more assets, thus driving up their prices. It also had the effect of boosting profits for the companies servicing these derivative transactions (think AIG) and the brokers.

We are told that these government bailouts and Federal Reserve lending programs are to offset subprime mortgage losses. If that was the only problem, this crisis would be over long ago. But that is not where the bailouts are going. They are going to offset the black hole of losses in the derivative portfolios of the big banks. And that is why 2 or 9 or 50 Trillion dollars in bailout money is not going to have any effect on reviving the economy.

There are also demographic and social trends that are working against the ever-expanding credit mentality of the last 4 decades. This is why I roll my eyes when so-called "optimists" ask me why I'm so sure that none of this will work and that we won't be seeing a recovery in the second half. Confidence will never be restored to the derivatives markets because the previously overlooked possibility of counterparty risk has been introduced. The securitization model of lending is therefore kaput. And all of these things were used as collateral for speculators to push up the value of assets worldwide. There is no other possible outcome to that than a severe deflation and reorganizing of the productive economy.

Financial services cannot be the main driver of the economy. Perhaps it can for city states like Singapore or Liechtenstein. But for larger countries, the financial services sector must be much smaller than the economy itself. That is, shuffling paper is not nearly as productive as producing goods or servicing the production of goods. When a true recovery comes, it will not be because we found a new way to rearrange the deckchairs on the Titanic. It will be because enterprising individuals have found better and efficient ways to make stuff and sell it to others.

The central banks are still trying to convince us that they can reshuffle all the paper and the economy will work just like new again. The problem was too much paper shuffling in the first place. The central banks have lost all control and have simply resorted to giving away as much of the taxpayer's money as possible (in one way or another) before the ship sinks.

The best thing the Fed, BoC, BoE, ECB, BoJ, RBA and the rest of them can do is use their last bullet on themselves.

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1 comment:

Anonymous said...

brilliant piece matt. I wholeheartedly agree with everything you say, i'd also like to point out that i've become fatigued with the incessant optimism in the msm....along the lines of the 'govts. and central banks know what they are doing and will sort this mess out by shuffling some bits of paper. this'll all be over by Q4 and house prices can shoot back up, etc. ad nauseum'

I'm from the UK, and our govt. has setup all sorts of initiatives to insure the bad assets of the banks who've been recapitlized....the numbers for which we've long since stopped tracking. 240bn to insure bad assets, special liquidity funds of 50bn, the cost of buying preference shares in the failed banks, full nationalisation of former mutuals northern rock and brandford and bingley...

On top of all those commitments [which must now exceed a trillion surely] they appear to have strong-armed the part-nationalised banks and reversed the policy of the nationalised northern rock to make available for lending tens of billions of pounds sterling to consumers and business. I have no problem banks lending working capital to business or mortgage loans to people who can prove their income....but the govt. are living in a dream world of wanting the banks to lend at 2007 pre-crisis levels, a clear case of the FIV mish talks about as the BoE embrace ZIRP to stimulate the taking on of more debt by the populace. Our level of private indebtedness is second only to the US i understand... IT's absurd but none of it is ever challenged in the msm.

Now the latest and greatest insanity, the BoE have embarked on quantitiative easing, the first couple of days have been hailed a 'success' [for the BoE anyway] as the banks fell over themselves to take part in the auction [mmm, wonder why ?]. non-banks haven't yet entered the fray.

What do you think are the outcomes from the BoE's qe policy and is it one of those that will run and run as the BoE encounter a very japanese problem ?

keep up with the good work re the blog. I'll add your blog along with those of mish and UWS professor steve keen, as indispensable reading on this crisis.

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