More Cash and Credit: How the Economy got Here in the First Place

It is snowing this morning… winter is not over; in fact the worst weather of the year may still be ahead.

Yesterday, the Dow held steady, after falling 315 points on Friday. Gold rose again – another $11… to $986. It looks like $1,000 gold is only days away, which means that $2,000 gold can’t be far behind. And when it gets here, we know our Dear Readers will be ready. Find out how you can prepare yourself to fully profit from this epic rise in prices here.

This is the big month, when mortgage resets peak out – with nearly $120 billion worth of mortgages being adjusted upwards. Naturally, you’d expect Americans to be feeling pinched… especially with prices of energy and food at record levels.

“Americans start to curb their thirst for gasoline,” says a Wall Street Journal headline.

Car sales fell in February – as you’d expect. Retailers report slower sales. And the economy itself, when last measured, was neither moving ahead… nor retreating, but stock still.

This has prompted a rush to judgment on the part of some critics:

“The Federal Reserve’s Rescue Has Failed,” announces a headline in the English paper, the Telegraph. Ambrose Evans-Pritchard, the paper’s business editor, says, “The verdict is in. The Fed’s emergency rate cuts in January have failed to halt the downward spiral towards a full-blown debt deflation. Much more drastic action will be needed.

“Yields on two-year U.S. Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter. The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.”

Mr. Evans-Pritchard then brings up New York’s Port Authority, which operates bridges, bus terminals and airports in the New York, New Jersey area. The Port Authority is backed by both state and federal governments. Yet, when it went to borrow money, it was treated like the junkiest of junk credits… forced to pay 20% rates.

“I never thought I would see anything like this in my life,” said James Steele, an HSBC economist in New York.

“No sane mortal needs to know what term-auction means, except that it too became a tool of the U.S. credit alchemists,” continues Evans-Pritchard. “Banks briefly used the market as laboratory for conjuring long-term loans at Alan Greenspan’s giveaway short-term rates. It has come unstuck. Next in line is the $45 trillion derivatives market for credit default swaps (CDS).

“Sub-prime debt is plumbing new depths. A-rated securities issued in early 2007 fell to a record 12.72pc of face value on Friday. The BBB tier fetched 10.42pc. The ‘toxic’ tranches are worthless.

“Why won’t it end? Because US house prices are in free fall.”

The article goes on to mention that we are only half way through the mortgage-reset storm. Expect more bad weather, says Evans-Pritchard.

But here at Markets and Money , we are in no hurry to pronounce judgment on Ben Bernanke’s plan to save the U.S. economy. We don’t have to. We knew it was a mistake from the very beginning. Exactly how the markets would react, we couldn’t say. But the idea of rescuing people from too much debt by lending them more money struck us a bit like serving martinis at an AA meeting; it was bound to lead to trouble.

The trouble we seem to be getting is popularly known as ‘stagflation.’ Prices rise, but so does unemployment. It wasn’t supposed to work that way. Inflation was supposed to spur consumers to spend money and businesses to hire people. But people eventually catch on to the trick. They eagerly get rid of money… and prices do rise. But they also come to realize that it’s not a real boom… but a phony boom… So, businesses do not expand… do not hire… and do not earn more money. They raise prices, but their costs go up too.

Still, the ‘stagflation’ label is reassuring to people. Those over the age of 40 can recall the stagflation of the Nixon years. In retrospect, it didn’t seem so bad. But there, too, we part company with most observers. It wasn’t so bad then because America’s economy was much, much stronger – strong enough to take Paul Volcker’s bitter medicine… and survive.

This time, the financial authorities aren’t even opening the medicine cabinet. They’re afraid the patient couldn’t stand the treatment. Instead, they’re administering the old elixir that got the economy into serious problems in the first place – more cash and credit.

Different circumstances… different treatment… we will surely get a different result. Stay tuned…

*** The costs of the credit crunch are mounting up. Each estimate is bigger than the one than before it. The latest estimate from the Union Bank of Switzerland is $600 billion. Economist Nouriel Roubini goes even higher – at $1 trillion. Of course, those are just the direct losses… the disappearing cash. There are also losses in implied wealth (and subsequent changes in spending and retirement plans) from falling house prices themselves. The residential housing market is worth some $20 trillion. If it goes down 30% from top to bottom, as expected, that’s a loss of more than $6 trillion.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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