Friday, March 21, 2014

The Facts about the Fed’s Dangerous Credit Bubble

by Bill Bonner

Treading Water on Borrowed Money

As promised, today we enter the time that hasn’t come yet … the point where the poor camel’s back gives way.

On Thursday, the Fed announced it would withdraw another $10 billion of artificial demand from the US bond market. And Janet Yellen let slip that the Fed would consider raising short-term interest rates about six months after QE ends. The Dow fell 114 points. Gold dropped $17 an ounce. What to make of it?

You’ll recall that, as long as ZIRP (zero-interest-rate policy) continues, the Fed is draining more and more resources from the future. It encourages people to borrow – by dangling near-zero interest rates in front of them. This debt must be serviced and retired from future earnings. This reduces the amount of capital available for current wants and needs. Thus the future is placed in debt bondage to satisfy the desires of the here and now.

The whole world is in on it. With total global debt of $100 trillion, even if the world could set aside $5 trillion a year, it would take about 30 years to pay off the debt (including interest at “normal” rates). But the world cannot set aside $5 trillion a year. It can’t even stumble along at break even. Instead, every year it needs an extra $5 trillion of borrowed money (net) just to stay at current levels of unemployment, asset prices, consumption and interest rates!

In other words, today, instead of paying down the past debt, we borrow more from the future just to stay in the same place.

After the Highs, the Lows

The question on the table the other day: How much future is left?

We didn’t have an answer. Today, we tackle an easier question: What will the future look like when it comes? We refer, of course, to that part of the future when the you-know-what hits the fan.

As we began to explain two days ago, the typical result of asset price inflation is asset price deflation. That much is guaranteed. And it could begin any day. US stocks were the main beneficiaries of the Fed-induced credit bubble. They will, most likely, be the main victims when the credit bubble bursts. Then the record highs of the recent past will be matched by record lows.

Nature loves symmetry. That’s just the way it is. What goes up must come down. Booms in margin debt, stock buybacks, junk bond issuance, and stock and bond prices will all be followed by terrible busts.

This is as it should be. It is natural. It is healthy. The junk is flushed out … the bad decisions and mistakes are cleansed … economic life can go on. A new boom can begin.

Of course, a real recovery would moderate the bust. Higher incomes, higher sales, higher profits – all contribute to the kind of growth that makes debt less of a burden.

No Recovery

Do we have a real recovery?

The official statistics tell us we have the weakest recovery since the Fed began instigating them. But a closer look at the figures tells us that there is no recovery at all. Auto sales, house sales, household incomes – all are either flat or falling. You have heard, of course, that the unemployment level has fallen to 6.7%. You have also heard, we suppose, that much of the drop is attributed to older people who have simply retired.

But it isn’t true. Instead of retiring, old people have held onto their jobs like drowning men clutching to their life preservers.

The numbers tell the tale. The age group that has contributed most to the falling labor participation rate is the group in the prime earning years: 25 to 54. Workers over the age of 55, on the other hand, have actually increased their participation in the labor pool. They added 3% to the labor force; the younger group subtracted 4.7%.

Why would older people want to keep working? The obvious answer: They don’t have enough money to retire. Young people, meanwhile, need to work. There is no question of retirement. But they can’t find jobs.

In other words, the data used to prove that the economy is well and truly recovering proves just the opposite. And here’s something else: The failure to bring a real recovery is the only thing allowing the bubble to continue expanding …

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