Chinese Housing Bubble, Dark Moon over New York, Impact of Corrupt Politicians on economy, Money Supply vrs Monetary Velocity, New York Fog, New York Night Skyline, Prim Watsa, The need for sound monetary policy
There has been a cold wind blowing for some time, a distinct chill hinting at a coming storm. For awhile pundits have been talking about a new economic paradigm, one where each sign of mediocre growth is greeted with ecstatic applause. At the same time, others have been warning of an economy on the brink.
Seven years since the housing bubble burst, the world’s great economies are still on a I.V. drip of freshly printed cash. This drugging of the economy has gone on so long that the markets have become junkies, addicted to the flow of easy money. Meanwhile, little of this money has found its way into the economy, instead it has been used to prop up stocks, bonds, and even housing. Creating fresh bubbles of inflated worth. Even as the money supply has expanded exponentially, the actual speed that it flows has been dropping just as fast (see the graph below)
Inflation and deflation are dependent on the product of monetary velocity and the money supply divided by the desire to buy goods and services. With velocity dropping, the central bank wizards tried to offset the correction by increasing the money supply. All in a vain attempt to forestall deflation (something needed to balance out the collapse of the bubble). Unfortunately, the desire to forestall deflation resulted in a feedback loop, where the more money is injected into the economy the more the velocity slows, the more money is needed to offset deflation. This kind of loop has never been seen before, and the central banks seem stumped on how to exit from it!
The first, and likely last, chance to exit from the loop was in 2010. When the economy showed signs of real growth, a combination of raising interest rates, and loosening the regulatory and tax burdens might of eased the balancing of prices. Now the world is stuck, and the signs are that the end of road is near.
It was perversely poetic that at the same time President Obama was out hyping a recovered economy, Citibank declared the world to be in a economic death spiral. This comes almost a month after RBS (the Royal Bank of Scotland) warned its investors to dump their stocks, and all but the highest quality bonds, before a cataclysmic market collapse.
What makes this situation all the worse, is that it is a world wide phenomenon. China never let its economy correct either, and its real estate bubble dwarfed that of the west. Japan has printed money even faster than the U.S. and Europe’s massive welfare state makes real reform almost impossible. All have been relying on central banks to do what the political institutions won’t or can’t deal with. The problem is that the bank actions have only delayed the inevitable, while making the end result much worse.
None of this is news to the world’s financial movers and shakers. German Finance Minister Wolfgang Schaeuble said in September of last year that world was in a monetary bubble. He also stated that bank actions can’t be seen as a substitute for economic reforms. Nonetheless, that is what was done. Gutless, and ideologically blind, politicians have used the banks to prop up their economically damaging agendas. Implementing higher taxes, and high impact regulations, while at the same time sustaining or even expanding government largess, they have put a boot on the economy’s neck. All the while the banks have been trying to keep the patient alive with a drug that is, in the long term, just as lethal.
Presently credit is tightening due to a slight easing of monetary expansion. As a consequence, we are seeing a string of corporate defaults, collapsing commodities and even looming currency wars. Adding to the chaos, the Chinese are no longer able to hide their economy’s structural issues, oil dependent countries are reeling from the precipitous drop in oil, Europe’ still has debt problems, and there is a well founded fear of deflation.
How things will exactly play out is a matter for tea leaf readers and psychic prognosticators, but the fact that the world is in between the rock of a great bubble and the hard reality of some level of economic collapse is becoming readily apparent. Recession is nearly guaranteed, depression likely and even worse a stark possibility.
Economics is balancing act, constantly trying to keep supply and demand, prices and costs, interest rates and risks, innovations and needs/wants etc all in equilibrium. Politicians are in the business of putting their thumbs on these scales to benefit their constituencies. When central banks are relegated to just maintaining sound monetary policy, political foolishness is limited. Havoc created by bad policies become quickly apparent and is corrected for. On the other hand, when central banks print money to delay the consequences of bad policies, the result is economic chaos is allowed to ferment. All the while, the author of it basks in the glory of false achievements. That is the state of world affairs, and reason for the mess the world is in.
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