Albert Einstein once said that the definition of insanity was doing the same thing over and over again and expecting different results. Through that lens, the current course of fiscal and monetary policy is absolutely insane.
One would hope we’ve learned from the past as we prepare for the future but there’s little evidence we have. Consistent with previous patterns of government intervention, policymakers -- many of whom never saw the cumulative imbalances building -- have overcompensated with reactive response and created the conditional elements of the next phase of crisis.
According to Scott Reamer of New York based hedge fund Vicis Capital, global central banks and government agencies have thrown upwards of $30 trillion dollars at the markets through direct lending and indirect backstops, with roughly 65% of that coming from stateside sources. That begs the natural question of whether the needle is now pointing towards hyperinflation.
"Not necessarily," says Reamer, "If they were creating currency, that would be the most probable path and I would own any physical asset I could get my hands on. But since they're creating credit, it’s an entirely different analysis with regard to how other countries will respond."
That jibes with my view that we’re sitting at a critical crossroads, one that will come to define the socioeconomic state of the world; the resulting dynamic may indeed be binary.
The first scenario is the continued socialization of markets, bearded nationalization of troubled institutions, and inflation through dollar devaluation, punishing savers who’ve preserved capital. By administering drugs that mask the symptoms rather than medicine that cures the debt disease, the crisis could evolve from the percolating societal acrimony to social unrest and, quite possibly, geopolitical conflict.
The other path is the destruction of debt that paves the way towards true recovery through an eventual outside-in globalization. This dictates a higher dollar and lower asset classes in the intermediate-term but creates a solid infrastructure for economic expansion thereafter. It would be a bitter pill for many to swallow but most medicine that works typically is. Lifestyles of the Rich vs. A Struggle to Exist
The banking system, stymied with credit dependency, is not operating normally. Hidden behind a litany of bailouts, stimulus, conduits, mortgage freezes, foreclosure programs, working groups, and government sponsored investment efforts are politicians attempting to engineer a business cycle that long ago lost its way. Also read Anatomy of a Recession
Alan Greenspan was the chief architect of this grand experiment, trying anything and everything to juice risk appetites -- including his infamous endorsement of adjustable rate mortgages -- before whispering “recession” over his shoulder as he rode into the sunset. He then handed the economic reigns to Ben Bernanke, a gentleman who once opined he would “drop money out of a helicopter” if necessary to induce inflation.
Deflation in a fractional reserve banking system means policymakers have, for all intents and purposes, lost control of the economy. It would also impact the top-tier of the societal spectrum tied to financial assets, which would be problematic for politicians and the constituencies that bankroll them. Election aspirations, however, may be the least of the concerns; this economic maelstrom is bigger than any particular political agenda.
Policymakers understand the enormous stakes given our derivative-laced finance-based economy. They’ve postured, positioned and proffered assurances, pulling out all the stops in an attempt to flush the system with liquidity despite the clear and present danger of a total system unwind, with currency markets possibly providing the release value. See How Realistic is a North American Currency?
As the state of our economic union steadily deteriorated the last eight years -- a dynamic masked by the lower dollar and skewed by the spending habits of a slimming margin of society -- the greenback was intentionally devalued with hopes that a legitimate economic recovery would replace the debt-induced largesse that dominated this decade.
As the world reserve currency lost 38% since 2002, foreign holders of dollar-denominated assets have grown increasingly frustrated with the status quo. Liu Mingkang, chairman of the China Banking Regulatory Commission, and Don Tsang, Chief Executive of Hong Kong, are among the latest leaders to voice displeasure, warning of “unavoidable risks” and “the next global crisis,” respectively.Pick Your Poison
Shortly before the credit mess arrived in September 2008, we warned it would manifest as a cancer or a car crash. The government responded by buying the cancer and selling the car crash, staving off a systemic collapse by inhaling the disease in its entirety. It worked, but it came at a profound cost. For more, read Pirate’s Booty
Asset classes continue to trade as a monolithic monster on the other side of the dollar. We call this dynamic “asset class deflation vs. dollar devaluation” in Minyanville and while both sides of the equation can decline, they would be hard pressed to rally in sync. That’s important to remember, particularly as the carry trade becomes part of the mainstream lexicon.
The favored scenario of those pulling the strings is akin to a bovine relay race. The 2009 government sponsored euphoria enabled corporate America to roll mountains of debt, potentially buying them a few more years. If the plan plays through, those same corporations will transfer the risk (through issuance) to an unsuspecting public before the next wave of crisis arrives. Rinse and repeat again and again, consistent with the definition of insanity.
This progression is predicated on the rest of the world cooperating, presumably because they’re unable to extricate themselves from the interwoven financial machination. The other alternatives are isolationism and protectionism, which could conceivably separate world commerce into standalone regions as nations attempt to protect their interests at all costs.
While the path of deflation and debt destruction would cause paper wealth to evaporate, it would forge a path towards a prosperous future. Rich nations would pour real money -- as opposed to cheap debt -- into developing economies as a redistribution mechanism of wealth and the resulting global community would be more profitable, and dare I say safer, for generations to come.
It’s not too late to reverse the curse of the lost cause of capitalism. If our policymakers make proactive decisions, demonstrate humility, and take steps to rebuild a stable foundation for the future, we could avoid waking up one day to find that our policy has been altogether outsourced to foreign central banks.