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3 CREDIT BUBBLE
madness Commentary and weekly
watch by Doug Noland
In commemoration of
the M2 money supply in the United States
surpassing US$10.0 trillion for the first time -
not to mention the unfolding confrontation between
European Central Bank (ECB) president Mario Draghi
and Germany's Bundesbank - this week's Credit
Bubble Bulletin will focus on monetary analysis.
It is worth noting that M2, the Federal
Reserve's narrow measure of "money" supply,
surpassed $1 trillion for the first time in 1975.
It made it past $2 trillion in 1983, $4 trillion
in 1997, $8 trillion in 2008 and $9 trillion in
April 2011. M2 has inflated another trillion
during the past 15 months.
To set the
backdrop, it is worth noting that early economic
thinkers were obsessed with money. These days, monetary
analysis is little more
than a footnote in contemporary economic doctrine.
Generations ago, great minds were trying to come
to grips with monetary phenomena. They came to
appreciate that money and credit had profound
impacts on economies and societies, although
throughout history even the most astute struggled
with the complexity of it all.
"monetary stimulus" is seen as good for the
markets and, yes, good again for gross domestic
product (GDP). Inflation, if it ever were to
return, is not so good. Today's monetary analysis
is not good but it is shallow.
things economic long ago appreciated that the
functioning of economies was literally transformed
by the introduction of money. An economy dominated
by barter operated altogether differently after
units of exchange entered the fray. They further
understood that the introduction of bank lending -
where new purchasing power and bank liabilities
were created by the act of borrowing - added great
complexities to how economies functioned. Finance
mattered and it mattered a lot. Keen attention was
paid to the role credit played in economic cycles.
For centuries, the seemingly
straightforward issues of money and credit were
recognized as extraordinarily, incredibly complex.
Analyses that various monetary fiascos and
inevitable collapses came to similar conclusions:
sound money and credit were paramount. Credit and
speculative excesses were recognized as primary
culprits to financial collapse and the Great
Depression. Regrettably, incredibly important
lessons learned through devastation and hardship
were relegated to the dustbin of history.
Early analysis of "wildcat banking" was
quite insightful. Especially as banks proliferated
along with the development of the Wild West,
individual banks' bills of exchange and promissory
notes garnered considerable attention. These types
of bank liabilities differed greatly, based on
their backing and the perceived soundness of
individual institutions - depending as well on the
phase of the credit cycle. In the end, there were
too many bank failures, too much worthless wildcat
currency and too little confidence in these credit
instruments and institutions.
however, wildcat fiat "money" was initially a
crucial facet of impressive wealth creation. Many
a prospector borrowed from a local bank to clear
land, buy seeds and invest in animals and tools.
Many businesses flourished.
thinkers, however, also recognized that unsound
money would inevitably prove destabilizing and
detrimental. Monetary inflations could not be
controlled. Lending volumes - along with
outstanding fiat currency - would inevitably grow
larger and larger, financing speculative
activities and uneconomic ventures - fueling
inflation and sowing the seeds of boom and bust
dynamics. This is a common theme throughout
monetary history, although monetary analysis is
always burdened by the fact that every cycle has
its own financial and economic nuances. The nature
of the analysis is prone to historical
But I'll conclude the
shallowest analysis of monetary history - and jump
right to the present. I've for years posited that
we live in an extraordinary period of "global
wildcat finance." Fiat electronic credit - much of
it marketable debt instruments - has expanded
unlike anything previously experienced. In the
"developed" West, inflated real and financial
assets were a primary inflationary consequence.
In China and "developing Asia" an
unprecedented expansion of manufacturing capacity
was integral to the incredible inflation of
incomes and wealth. As for fundamental "nuances"
of this monetary and economic bubble, one can
point to so-called "globalization", the explosion
of computer and communications technologies,
enterprising financial innovation, deregulated
credit and speculation, and monetary policy
Myriad forces worked to break
the traditional link between monetary excess and
rapidly rising consumer prices. The "developing"
world, enjoying access to unlimited cheap finance,
built manufacturing capacity to inundate the world
with manufactured goods and technology products.
Global financial excesses allowed developed
nations to indulge in cheap imports by issuing
endless IOUs, while transforming economic systems
from production-based to credit-driven consumption
The seeming New Paradigm
victory over "inflation" emboldened New Age
central bankers. They unwittingly nurtured an epic
monetary inflation, and as this credit bubble has
begun to buckle they have moved with extraordinary
force to sustain it. Especially after the 2008
crisis response, global policymakers lost control.
The eurozone is today locked in a
disastrous monetary crisis. The marketplace simply
no longer trusts the liabilities issued by some
its members. Analysts continue to lambast European
officials for failing to learn from our successful
navigation through the 2008 crisis. This is flawed
Europe is suffering from a
late-cycle sovereign debt crisis. In '08-'09, US
policymakers enjoyed unprecedented demand for
Treasury (and even agency) debt securities.
Through the massive issuance of federal government
debt along with Federal Reserve monetization, the
US system was able to sustain ongoing credit
growth. US non-financial debt expanded $1.9
trillion in 2008 and, despite huge mortgage
write-downs, US non-financial credit still grew
almost $1.1 trillion in 2009.
debt expanding a then record $1.4 trillion, total
non-financial debt expanded 3.1% in 2009.
Washington was willing to jeopardize the credit
worthiness of federal debt and the Fed was willing
to risk its reputation - and a downward spiral was
thwarted. A new phase of monetary inflation was
commenced, this time through the massive injection
of federal government and Federal Reserve finance.
There are unappreciated costs associated
with injecting such massive sums of unproductive
credit into a (maladjusted) system, which I return
to below. Today, because they now lack credit
worthiness in the marketplace, Spain and Italy no
longer have the capacity to inject sufficient new
credit into their economic systems. This is a
potentially devastating dynamic, as the lack of
sufficient ongoing monetary inflation is
illuminating deep structural economic impairment
following years of credit excess and attendant
Early last week, with
Spanish and Italian yields spiking higher and
their markets turning illiquid, the European debt
crisis was again spiraling out of control - only
months after the ECB implemented its latest $1.3
trillion liquidity facilities. And, once again,
acute financial stress has provoked tough talk.
ECB president Draghi on Thursday morning
stated, "... the ECB is ready to do whatever it
takes to preserve the euro ... Believe me, it will
be enough." German Finance Minister Wolfgang
Schaeuble said he supported Draghi's statement,
while Chancellor Angela Merkel and President
Francois Hollande came forward on Friday with
their own "bound by the deepest duty" to do
everything to protect the euro.
was Friday afternoon's unconfirmed report that
Draghi is prepared to present a "game changing"
multi-prong plan at this week's European Central
Bank governing council meeting that will include
ECB bond purchases and a banking license for the
European Stability Mechanism (ESM).
Shifting 180 degrees from earlier in the
week, rather than fearing credit collapse the
markets moved quickly in anticipation of yet
another crisis-induced bout of monetary inflation.
And, seemingly, only the Bundesbank remains
capable of taking a measured approach.
Friday morning (before afternoon reports
of a Draghi's "game changer"), from a Bundesbank
spokesperson: "There haven't been any changes in
our positions on bond purchases of the Eurosystem,
bond purchases by the EFSF [European Financial
Stability Facility], or giving a banking license
to the ESM ... The Bundesbank has repeatedly
expressed in the past that it views bond purchases
critically because they blur the line between
monetary and fiscal policy ... The Bundesbank
continues to view the SMP [securities market
program] in a critical fashion. The mechanism of
bond purchases is problematic because it sets the
wrong incentives ... A banking license for the
bailout fund would factually mean state financing
via the printing press and would be a fatal route,
which therefore is prohibited by the EU [European
No doubt about it, the
Bundesbank is increasingly isolated. They are at
odds with most European politicians and they are
at odds with other central bankers. They are
clearly not on the same page with Draghi. And no
group of government officials anywhere more
clearly appreciates myriad risks associated with
view of economics just has a very different
perspective, and it goes way beyond some fixation
on Weimar hyperinflation. The focus is on how real
wealth is created and how wealth is destroyed.
Monetary inflations are powerfully destructive.
And as a deepening European crisis applies
incredible pressure on politicians throughout the
region - certainly including Germany's Merkel and
Schaeuble - I suspect the Bundesbank will hold its
ground. They are both right on the analysis and
have the support of the German people. They
understand that the German economy cannot support
the massive debt of the entire eurozone.
Italian two-year yields
jumped from 3.80% on Monday morning to 5.18% by
Wednesday morning. By Friday afternoon they had
sunk back down to 3.6%. Spanish stocks dropped
5.8% last Friday, declined 1.1% Monday and another
3.6% on Tuesday. They gained 0.8% Wednesday,
before jumping 6.1% Thursday and 3.9% Friday.
Italian stocks dropped about 10% in three
sessions, before rallying 10% in the next three
sessions. US stocks dropped 3% in three sessions
and then gained 3.5% in two. German 10-year yields
ended the week up 23 basis points (bps).
Throughout already volatile global debt, equities,
currencies and commodities markets, things have
turned only more unstable. There is no doubt in my mind that ongoing
monetary injections, albeit European, American,
Chinese, or others, come with the cost of
increasingly unstable - I would argue perilously
dysfunctional - global financial markets. And
there should be little doubt where Draghi was
directing his "trust me, it will be enough" tough
talk (kind of reminded me of, "go ahead, make my
day"). The Europeans believe hedge fund and other
speculator bets against their bonds, stocks and
euro currency are a major contributing factor to
the region's woes. There wasn't an issue back when
speculators were leveraged long Europe's
(Greece's, Spain's, Italy's, etc) securities
during the upside of the cycle.