This Credit Event Could Crush the US Stock Market

Now our nerves are settled. We can sleep at night. There’s nothing more to worry about. Christine Lagarde, head of the IMF, has reassured us.

Madame Lagarde tells us that further scaling back of QE won’t mean a thing, as long as the Fed goes about its tapering in a gradual, measured way, which of course it will.

We don’t anticipate massive, heavy and serious consequences,‘ she said.

But wait…

She must be wrong about that. If the Federal Reserve were to continue to cut back its bond-buying, the US stock market and the economy would go into withdrawal shock. The economy would wobble. Stocks would fall. And Janet Yellen would promptly go into a huddle with other Fed governors and come out with an announcement: more QE!

We don’t know whether Madame Lagarde is aware of it or not. Fed economists must be. They must know that the only thing keeping the economy from slipping into recession is the Fed’s EZ credit.

The following figures were shown to us by economist and author of The New Depression: The Breakdown of the Paper Money Economy, Richard Duncan. He spelled it out for us…

Since the 1980s, we have had an economy that grows on credit. In 1964, the global economy owed only $1 trillion. By 2007, total global credit had expanded to $50 trillion. The global economy depends on it.

But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one.

When credit growth slows, so does the economy.

How much credit growth does it take to keep the economy chugging ahead? Duncan says it needs an increase of at least 2% after inflation, or the economy goes backward. Every time credit growth has fallen below 2%, he says, we have had a recession. No exceptions.

A growing, expanding economy naturally leads to more credit. Households borrow for new homes and appliances. Businesses borrow for new plants and machinery. Investors borrow to finance startups and speculations. Government borrows, too, to cover deficits. And all this borrowing is what leads to new demand, new jobs and new output.

But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one. The real economy limps along. Real per capita disposable income has risen just 0.7% a year over the last five years. The personal savings rate is only 4%. (It was 10% in the 1980s.) And although the consumer deleveraging cycle is over (for now) much of the new credit creation is once again in the subprime category. (Last year, Wall Street secured $20 billion in subprime auto loans!)

Although the Fed has been unable to do much about the real economy…in the financial economy it’s wrought wonders! That’s the secret to understanding the markets, Duncan explains. It depends on the difference between how much credit the economy needs and how much it gets. The excess is what drives up asset prices.

That’s why the rich have gotten so rich lately…

The markets take excess credit and use it to bid up asset prices. Stocks rise. Real estate prices go up. (The average house price is back at over $200,000.)

Household net worth – heavily concentrated in the upper reaches of the socio-economic pyramid – rose $8 trillion in the last 12 months. It’s now greater than it was in 2007. And that huge increase appears to be the only thing keeping the economy from sinking.

Take away the QE, and you take the biggest single buyer out of the bond market. Bond prices fall (and yields rise). Stocks fall. Housing prices fall. And the economy, no longer buoyed up by the phony ‘wealth effect’, is suddenly pulled under by a real ‘poverty effect’.

Duncan tells us that all borrowers put together are likely to ask for $2.2 trillion worth of credit this year. That is a 3.8% increase. But that’s before inflation. Take off 2% for rising prices, and the real increase falls short of the 2% needed to avoid recession.

So, here’s what happens. The Fed has to keep peddling cheap credit, or the economy falls into recession. Some of it is absorbed by the bond market (mostly US federal deficits).

Anything more than is needed to fund credit demands is the ‘excess liquidity’ that drives the asset markets. Stocks soared in 2013 because the Fed overfunded US credit demands (the US budget deficit declined).

The Fed is driving the economy,‘ says Duncan.

The feds broke it. Now, they own it.

Over the next six months, Duncan sees no problem. There will be enough excess liquidity to keep asset prices moving up.

But then, watch out.

Regards,

Bill Bonner
for Markets and Money

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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 MoneyDice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill's daily reckonings from more than a decade: 1999-2010. 

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4 Comments on "This Credit Event Could Crush the US Stock Market"

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Greg
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Bill,

Excellent classical approach and logic as always ;)

With such a clear view, it is much easier to plan the defence strategy
– even for the ordinary reckon-er ;)

Many Thanks ! and keep excellent reckoning !

Greetings from London !

slewie the pi-rat
Guest

your credit is no longer good?
find another neighborhood!
cargo-cult casino gotcha down?
we’ll appoint another clown!

can-kicking economic & atomic wastes not workin’?
join the twerkin’ round the Gherkin!
and sing this prayer with all your frens:
“Oh Lord! won’t You buy me a Mercedes Benz?”

McRoy
Guest

But think of the good franchise that will come out from all of this, for instance, the Soup Kitchens everywhere will flourished or the tent making business etc..

Lachlan
Guest

Oooh London! Greg you could row over to Jersey and get some real money off Mr Turk ;)

wpDiscuz
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