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Musings Report 2020-34 8-22-20 Staring Down Financial Collapse: Who Gets Saved and Who Gets Culled?
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Staring Down Financial Collapse: Who Gets Saved and Who Gets Culled?
Longtime Patron Daniel C. recently asked me to explain my recent posts on the US dollar strengthening and the ever-expanding global mountain of debt imploding.
This looks like a contradiction, as a collapse of the debt bubble would wipe out a monumental amount of bubble-era "wealth," what many of us call fictitious or phantom wealth. Such a collapse of "wealth" would trigger a collapse of the global financial system, which has become dependent on debt and the money supply both expanding smartly forever.
A collapse of the global financial system would naturally be expected to take down all the fiat currencies that are being printed with such abandon to support the debt bubble.
So how could the US dollar strengthen as the debt bubble pops? And what would happen to the global economy if much of its "wealth" vanished more or less over night?
Let's also add the spectre of hyper-inflation, which many of us see as the inevitable result of central banks printing enough currency to support the unemployed masses and the debt bubble.
How can we reconcile these contradictory forces? How can we anticipate the ebb and flow of these titanic financial forces?
These are precisely the questions we need to answer to successfully navigate the treacherous financial waters ahead.
This is a long and complex essay, my apologies, but no simplification will actually prove useful.
One place to start is to look at the financial system as responding to severe pain--financial and political pain.
Every constituency that could bring down the system is at risk or already in pain, and so the powers that be are struggling to find policies that alleviate everyone's pain.
Alas, that's not possible.
Let's start with the banks. Banks are the beating heart of the global economy, as buying or building almost anything requires credit.
As my colleague Rick Ackerman points out, currencies losing most of the value, a.k.a. hyper-inflation, wipes the banks out. If every employee starts getting paid $100,000 a week (because the purchasing power of the currency has plummeted), then every debtor can pay off their auto loan with one day's pay, their student loan debt with a week's pay and their mortgage with a month's pay.
The purchasing power of the money paid to the holder of the debt--the bank or wealthy investor who bought the mortgage as an interest-yielding investment--is near zero.
Banks and wealthy investors are politically powerful, and so they won't stand for the currency being hyper-inflated to near-zero value.
On the other hand, if the debt bubble pops and every $1 million bungalow slides back to being worth $200,000, then the collateral supporting all the loans/debt has vanished.
When people start defaulting on their $1,000,000 mortgage, the bank gets possession of a house worth $200,000. The bank loses $800,000. Banks cannot sustain these kinds of losses, so they are effectively bankrupted.Credit will dry up and the modern economy grinds to a halt.
But banks aren't the only constituency facing pain. As the central banks keep inflating asset bubbles--and remember, many of these assets are debt-- Treasury bonds, corporate bonds, mortgage-backed securities, etc.--the wealthy investor class keeps getting richer while the 90% who own few if any assets get poorer.
Thanks to financialization and globalization, wages earned by labor have stagnated for decades for 90% of the populace. As prices of assets keep rising, it gets harder for wage earners to buy assets. Meanwhile, prices for services keep rising because globalization only lowers the cost of manufactured goods, not services like childcare, local government, etc.
When people can no longer afford a lifestyle they consider the minimum due them, they revolt. Since this revolt could eventually threaten the powers that be, central banks are now scrambling to send cash directly to households. Right now this is called "stimulus" but soon it may be made permanent as Universal Basic Income (UBI) or an equivalent.
Without some sort of direct cash payment to the 90% who have lost ground, the system faces a political revolt.
The problem here, as I've explained in previous Musings, is that when you create trillions out of thin air and distribute it to households, they spend it in the real economy, triggering inflation/loss of purchasing power.
The basic dynamic here is that when central banks print a trillion dollars, it won't go into producing goods and services if it isn't highly profitable and low risk to do so. Instead it will go into financial assets, further inflating the asset bubble.
If the newly printed trillion is distributed to households, they spend it on goods and services, and this flood of money chasing a stagnant pool of goods and services creates inflation/loss of purchasing power.
In response, the central bank prints even more money, which then accelerates the loss of purchasing power, and so on.
On top of all this, the global dominance/hegemony of the American financial system/empire depends on the US dollar remaining the one essential reserve currency that everyone has to have and use.
You see the problem. if you inflate away the value of your currency, nobody will want it any longer and you lose the "exorbitant privilege" of the reserve currency.
What is the exorbitant privilege? To print money out of thin air and trade it for real-world goods such as oil, semiconductors, etc.
In developing world economies, the wealthy class evades the risks of their currency collapsing by holding their wealth in gold, overseas villas, Swiss francs, etc.--stores of value that have stood the test of time.
So when their local currency goes to zero and is re-issued at 100 old dollars to 1 new dollar, they're still wealthy. Everyone who held the local currency as "wealth" is wiped out.
As noted above, banks and wealthy investors in the U.S. are not going to be happy with the collapse of the USD currency. The global financial system can absorb the collapse of a small local currency but it can't survive the collapse of a reserve currency and all the assets/collateral denominated in that currency.
So the Federal Reserve and U.S. Treasury have an unsolvable puzzle. They have to keep inflating the asset bubble, as if they let it pop then all the debt implodes and banks/investors don't get their money back--they're bankrupt.
But to keep the masses from revolting as the rich accelerate away from the bottom 90% and wages/employment continue sliding, then they need to print and distribute trillions more dollars to the masses.
This will eventually cause inflation, which eventually threatens the currency itself.
The saying is "capital goes where it's treated well," and nobody wants to put capital in a currency that's losing value every day like clockwork. They want to put capital in a currency that's holding or increasing its value.
When global capital is flowing into an economy, life is good. When capital is fleeing the economy because of high inflation, life is not good--not for the average wage-earner and not for the wealthy, either.
Those privy to central bankers' meetings report that the people in these positions of power realize they're trapped, and they aren't happy about it, fuming, "What do you expect us to do? Let the whole thing collapse?"
The problem is whatever they have to do to keep it from collapsing only increases the risks and pain somewhere in the system.
For example: in a system dependent on debt expanding forever, the only way people with stagnant incomes can borrow more is if the interest rate drops. Now that rates are near-zero, the central banks are pushing on a string.
Meanwhile, banks need interest rates to be high enough to make a profit on lending. If they can't make a profit on new loans, it makes no sense to issue new loans, and the economy freezes up.
From this perspective, central banks have sacrificed banks' profits to reward speculators and the wealthy, and sacrificed the bottom 90% (wage earners) to reward the top 10% (owners of bubbling assets).
Now that central banks have pushed interest rates to zero, fatally wounding bank profits, they're going to have to redistribute the pain and the gains to reward banks and give speculators/asset owners the pain they've avoided for 12 years.
The only way they can relieve the pain of banks is to let interest rates rise, period. So that's what's going to happen, even as every financial pundit on the planet insists the Fed will force rates below zero. Since this will destroy the banks, I don't see this happening.
A rise in rates will surprise everyone, but it's really the central banks' only option. That will hurt equities and assets sensitive to interest rates such as housing.
So where does all this take us?
As much as they'd like to find policies that shower gains on everyone, central banks have to face the awkward reality that to keep the system from collapsing, they're going to have to distribute the pain not just to banks and wage earners but to the speculators and wealthy asset owners who've seen their wealth multiply over the past 12 years.
It seems to me that central bankers see the "solution" as distributing the pain as equally as possible, and in low enough doses that it won't trigger cascading bankruptcy or revolt.
Put another way, a "controlled collapse" is more favorable than an uncontrolled collapse.
So how do we prioritize all this?
1. The first priority is to defend the value of the currency, because if they let that collapse in hyper-inflation it wipes out everyone: banks, commoners and investors.
If they don't defend the currency's purchasing power, then the $1,000 a month given to every household will end up buying a single bag of groceries. Revolt will be inevitable.
2. The only way to defend the currency is to make it a magnet for capital, and the only way to do this is to raise interest rates so capital can earn a safe return.
3. If interest rates rise, that will suppress demand for everything bought with credit, leading to economic stagnation, and it will deflate asset bubbles because houses, stocks, etc. will no longer be rising just because interest rates keep dropping.
4. Rising interest rates are good for banks and those with cash and bad for debtors. For 12 years, central banks have kept zombie companies and households alive by enabling them to roll over their rising debts at lower rates of interest. Once rates start rising even slightly, the zombies will default and go bankrupt.
These defaults will pressure the banks because they'll have huge losses to report, but at least they'll be able to increase profits on new lending at higher rates.
5. Central banks can manage this "controlled collapse" of bad debt / over-speculation by bailing out the banks over time by raising rates and transferring the bad debt to their own balance sheets.
But somebody somewhere will still have to absorb losses, and so the trick will be to deflate all the asset bubbles slowly enough that they won't pop and collapse.
The bottom line is that central banks will be under unbearable pressure to print as many trillions as everyone needs to stave off collapse.
If they cave in to that pressure, they'll cause the currency to collapse.
They can't bail everyone out and distribute trillions to every household. All they can do is run around putting out the fires threatening collapse and respond to the screams of pain from every powerful constituency.
6. Between the collapse of the currency and a collapse of the debt bubble, which do you choose?
If you let your currency collapse in hyper-inflation, it's fatal to your system. If you let a speculative debt bubble pop, it's a heart attack that destroys trillions in phantom wealth, but the system can survive and recover.
Since 85% of the phantom wealth is held by the top 10%, if half of that wealth vanishes, the bottom 90% won't be directly affected, since they own so few of these assets.
Yes, the economy suffers a massive blow and a depression as zombies expire and speculators are handed some of the pain, but if the only other alternative is the destruction of the currency and the entire system, which is preferable?
This is why I expect the US dollar to strengthen, as letting it decline to zero isn't really an option.
Between hyper-inflation and a "controlled collapse" of speculative (phantom) debt/wealth, the banks would choose the "controlled collapse" if the central banks are absorbing most of the losses and letting rates rise.
The bottom 90% cannot survive hyper-inflation. They can survive if the currency they receive every month holds its purchasing power. Most can survive a decline in the bubble-value of their home.
The question is: can central banks control the deflation of the enormous debt/asset bubbles they've inflated, or will the "controlled collapse" they hope to micro-manage get away from them?
Put another way: can they let all the zombies expire without triggering unbearable pressure from powerful constituents?
Having inflated an increasingly unstable debt/asset bubble, they now face triage. Some "patients" will have to be abandoned to their fates to "save" the essential parts of the system.
The upside of the "controlled collapse" of debt/asset bubbles is costs for many things will fall, and life gets better for the majority when prices fall.
For example: when the overleveraged, over-indebted commercial landlord goes bankrupt, the building will be auctioned off for a fraction of its bubble valuation. The new buyer can charge $300 a month rent for the cafe space instead of $3,000 a month.
Someone might be willing to risk opening a cafe with the rent at $300/month, while at the old rent of $3,000/month, nobody could possibly make enough to stay afloat.
In the end, humans run in herds. We can't help it. If capital flees, the flight soon turns into a stampede and collapse ensues.
Central banks are ultimately playing a dangerous game of hoping all the weaker members of the herd will expire without sparking a panic-stampede.
History, I fear, is not on their side. But we can anticipate them trying to manage this culling because they really don't have any other choice. Better to let some of the herd expire rather than let the entire herd stampede off the cliff.
Highlights of the Blog
Podcasts:
AxisOfEasy Salon #18: The Endgame of Financialization Resembles a Philip K. Dick Novel (58 min)
Posts:
Big Tech, Monopoly and the Pretense of Capitalism 8/21/20
Will Skilled Hands-On Labor Finally Become More Valuable? 8/20/20
Our Systemic Drift to Collapse 8/19/20
The Empire Will Strike Back: Dollar Supremacy Is the Fed's Imperial Mandate 8/18/20
It's Do-or-Die, Deep State: Either Strangle the Stock Market Rally Now or Cede the Election to Trump 8/17/20
Best Thing That Happened To Me This Week
I was relieved to find that the loss of vision in my bad eye is caused by a burst blood vessel. The blood behind the lens in the eye should clear on its own. Whew.
From Left Field
The Unraveling of America (Rolling Stone)
Chloroquine and COVID-19: A western medical and scientific drift?
Do You Know the Difference Between Being Rich and Being Wealthy?
On The Verge Of An Energy Crisis
Why women leave medicine (via John F.) --this is important...
'We're making it up as we go along': how Trump's America failed the Covid test
Families with means leave public schools for private schools or ‘learning pods,’ raising concerns about worsening educational inequality
The Demise of the Happy Two-Parent Home (via Maoxian)
California Democrats divided over COVID-19 stimulus, millionaire tax to fund economic recovery (via Brandon R.)
How should California dig itself out of a $54 billion deficit? A divide between state lawmakers over how to generate revenue mirrors a national reckoning in Democratic politics.
NY’s largest hospital network had to buy garden hoses to fix ventilators (via T.D.)
US Crude Oil Production Plunged Most Ever, Natural Gas Followed: The Great American Oil & Gas Bust, Phase 2
COVID-19 Survivors Face Lifetime of Disability (via Cheryl A.)
Generations X,Y, Z and the Others (via Maoxian)
"Good advice is something a man gives when he is too old to set a bad example." Francois de La Rochefoucauld
Thanks for reading--
charles |
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