Alright then. So yesterday we made a claim that the Fed has ways of causing inflation in the same way that the Gestapo has ways of making you talk. But it was merely a claim. We didn’t prove it.
Today, we offer incontrovertible proof that the Federal government of the United States intends to inject money directly into U.S. households using an obscure provision of the recently passed Dodd-Frank shemozzle (only click on that link if you are masochist…it is a PDF of the entire Bill as passed by the thieves and rent-seekers currently passing themselves off as servants of the public in the U.S. Congress).
But first! The Reserve Bank of Australia published its latest Statement on Monetary Policy today and the good news is that, well, it’s all good, Australia. In the introduction to its report the RBA said that, “Over the period ahead, strong growth in resource exports and a gradual pick-up in business investment is expected to offset the scaling back in public demand as stimulus-related projects are completed.”
So that’s good news. Generally, the professional forecasting class of central bankers and economists has been lousy over the last few years. They keep telling us things are contained and fine. They get more wrong each time.
That’s not to say the RBA is wrong again, even though it didn’t see any trouble coming down the road last time around. And the Bank did go to great lengths to outline the risks to its bullish forecast. Emphasis added is ours:
On the downside, the main domestic risk is that the forecast pick-up in private demand does not occur as quickly as expected at a time when public investment is contracting. Internationally, there is some risk that the recent measures by the Chinese authorities to cool the property market will slow the Chinese economy by more than currently expected, causing commodity prices to fall and investment in Australia to be delayed. A significant retreat from risk taking around the world as a result of renewed concerns about the financial position of European banks and governments also remains a possibility, although the probability of this looks lower than was the case a couple of months ago.
Basically the RBA reckons the mining boom is being counter-balanced by recalcitrant consumers who refuse to borrow and spend at pre-boom levels. Net net, it’s all good baby! For sure, the chance that China could pop its property bubble might cause commodity prices to fall. But that’s no biggie either, apparently.
Speaking of which, yesterday we mentioned Chinese stress tests modelled a 50-60% fall in house prices and what that would mean for banks. Today, Bloomberg reports that, “Chinese regulators have demanded stress tests on a wide range of industries, including cement and steel, whose fortunes are closely tied to the property market, the official Shanghai Securities News reported on Friday.”
Right then. The steel bone is connected to the cement bone. The cement bone is connected to the coal bone. The housing bone is connected to the economic bone. And all dem bones could be brittle.
That is a casual way of saying China has had an investment-led fixed asset boom in infrastructure and real estate. Much of the boom was financed with borrowed money. If it turns out this was a massive mis-allocation of capital, it will have created a bogus price signal for Australian commodities. That always leads to bad decisions and a lot of people losing a lot of money.
The RBA, by the way, went to the trouble of elaborating on one of the big risks it cited in the introduction, namely Australia’s reliance on off-shore funding to power domestic lending. This funding is a combination of long-term and short-term funding, with the short-term funding being the most interest rate sensitive and therefore a big risk.
In a true credit crisis, you might be able to borrow off-shore to lend on-shore. But it will surely cost you more. That’s exactly what Graph “B1” shows below. When the average cost of borrowing overseas went up, so did interest rates here. The spread looks pretty fixed, if stable at the moment.
On this issue the RBA said, “Banks source the remainder of their funding largely from the wholesale short-term money markets. While spreads in these markets rose during the turbulence in May and June, they have since fallen back and remain around the average seen over the past year.”
That’s all well and good, provided there isn’t another credit crisis. But if there is – and there are lots of things that could provoke such a crisis – then you’d expect both rates to move up again, tightening credit in Australia. And if you think we’re making it up there’s this from today’s Age, “The heavy reliance of big Australian banks on overseas borrowings to fund their lending has left them vulnerable to shocks in the global credit markets, says a senior executive at HSBC, one of the world’s biggest banks.”
As any good student of the Great Depression knows, nervous and failing banks make bad lenders. New money created by bank lending off savings deposits has traditionally been the largest creator of credit in the economy, although non-bank lenders who fund themselves through securistisation are in vogue in the last ten years. But if, in a renewed credit crisis, banks fail or lending dries up, don’t we have the perfect storm for a great deflation?
Pimco’s Mohamed El-Arian thinks so. He says there’s a 25% chance of deflation in the US as corporations hoard cash and households increase savings rates. This general decline in real economic activity would lead to the liquidation of excess capacity in the economy and falling asset values (those boosted the most by credit creation in the boom).
How bad could it get for asset prices? We read Dr. Marc Faber’s latest Gloom, Boom, and Doom Report last night while dining at Barney Allen’s and nearly choked on our roasted chicken. Faber relayed the astonishing “Dow 1,000” prediction of Elliott Wave analyst Bob Prechter. Prechter argues the current bear market is a “supercycle” bear market and will be the biggest in 300 years, taking most indices back to levels where the bull market started.
Since the supercycle in fiat money started in about 1974 – around the time the world went exclusively to a dollar standard – Prechter argues for the Dow to make a low at least below its 1982 low at 777 and possibly its 1974 low at 572. Needless to say, that’s low.
It’s all worth pointing out that an asset market crash of that size – greater than 90% – while not unprecedented (see also Great Depression) – would be massively socially disruptive. Frankly, it would be the end of the civilised world as we know it and a long, miserable descent into poverty, violence, lawlessness, and death. That’s why, in today’s day and age, a printing press armed by Depression student Ben Bernanke will crank into action well in advance of a prolonged deflation.
We’ll leave aside the issue of what the best investment strategy is for such a scenario today. Instead, we want to take on the point that the Fed can’t actually cause inflation. Not yet, that’s true. Banks must lend and borrowers must borrow for the velocity of money to increase, as well as the quantity.
But as we live in extraordinary times, massively destructive monetary policy measures call for extraordinary measures. And in Title XII of the new “Wall Street Reform and Consumer Protection Act” we think we’ve found a smoking gun that reveals how the Feds will shoot up the economy with more junk credit: by funneling Federal grant money through FDIC-regulate banks upon pain of death.
You can read all of Title XII in its glory here. You should be tipped off by its title: Improving Access to Mainstream Financial Institutions. It’s no coincidence that in defining a “community development financial institution” the Title references the Community Development Banking and Financial Institutions Act of 1994. That was an amendment to the Community Reinvestment Act passed by Congress in 1977. The 1994 legislation opened the flood gates for Federally-backed mortgage lending to high-risk minority borrowers. It’s where the seeds of the bad lending that led to the American housing bubble were planted.
Here’s what part of Section 1204 looks like:
And here’s the key language in section B that shows how the Fed’s plan to encourage the banks to dispense Federal grants to low and moderate income individuals:
But wait. There’s more! Under section 1205, the Treasury Secretary is authorised, via eligible entities (like government owned, regulated, or brow-beaten banks) to apparently make loans to consumers directly.
Hmm. Sounds like just the sort of thing a community organiser would love! Access to Federal funds to dole out to consumers of your choosing. Hmmn.
Of course we may have read the law incorrectly. The whole purpose of the law is to provide an alternative t “pay day” loans which are viewed as predatory and extortionate. But just what the government means by “access” to financial institutions. It sounds to us like government-regulated lenders (and they are all) will be forced to loan government grant money to distressed Americans who can’t pay their mortgage or find a job.
The upside for the banks is that they won’t have to lend their own money. The downside, if you’re an American taxpayer, is that they’ll be lending your money, or money the Treasury has borrowed that you will have to repay. Worst case is that it’s money the Fed has created to “inject” into the comatose economy.
That money will destroy your purchasing power and lead to price inflation. How do we know? Because the mechanics of this community lending scheme look exactly the same as the whole policy-driven boondoggle that lead to the housing bubble…more assclowns in government who believe you can get something for nothing and use the law to plunder the economy.
So we’ve got that to look forward to. But at least it’s Friday! Next week, more on how inflation will be unleashed in an otherwise deflationary world. Until then!
for The Daily Reckoning Australia