Interesting chart from the Fed - Velocity of MZM Money Stock

[Storm]

http://research.stlouisfed.org/fred2/se ... ?cid=32242

"Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP."

What does this chart tell us about the future, for those of us that like to read the tea leaves?

[MediumTex]

It looks like a secular deflationary trend that the Fed has masked through decades of easy money policies.

I have no idea what it suggests about the future.

I do know, however, that without rising wages and a willingness of consumers to take on more debt, it's not going to turn around any time soon.

It looks about like the curve one might see of the quality of a drug user's high, even with increasing doses.  One projects in those cases that eventually the user will self-administer a lethal dose, hoping to get back to those beautiful early highs.

One of the most elegant and useful ideas from economics is the concept of diminishing marginal returns.  I think that chart suggests diminishing marginal returns from artificially low interest rates.

I wonder what a similar curve for Japan would look like.

The world has taken on too much debt based upon a mis-reading of what future economic growth was going to look like.  This mis-reading was the result of distorted market signals generated by decades of ill-considered monetary policies around the world.  The process of liquidating that debt will be neither quick nor easy.  The idea that generating more debt at lower rates will somehow ease the liquidation of debt that would be un-repayable even at 0% interest rates has not yet fully registered with many people.

Von Mises predicted all of this almost as a matter of common sense.

I think that one day in the future many of today's economists will be viewed as the flat-earthers of this era.  The flat-earthers were not dumb, they were simply experts operating within a flawed paradigm.

It's okay, though--the Permanent Portfolio's DNA has built-in protections against viral forces like starry-eyed central bankers.  That's why I think of Harry Browne as a genius and Alan Greenspan as a buffoon. 

[Storm]

Great points, MT.  I think you are right about masking a 30 year deflationary trend by printing money and inflating bubble after bubble.  You would think they would learn from history yet they keep repeating it.  I see easy money causing bubble, then recession in the 80s, 90s, and 2000s.

The interesting thing to note is that no matter how big they increase the money supply by printing, they can't seem to stimulate money velocity, which is the real key to economic growth.  What they might be able to do, however, is create another stock market bubble by letting the bankers play with their money for a while.

[Storm]

Here's another chart that shows just how deep this recession is and puts the new unemployment figures in perspective.

http://research.stlouisfed.org/fred2/series/EMRATIO/

[MediumTex]

Here's another chart that shows just how deep this recession is and puts the new unemployment figures in perspective.

http://research.stlouisfed.org/fred2/series/EMRATIO/

Ongoing secular demographic shifts will continue to place downward pressure on the labor participation rate.  This dynamic, in turn, will place continued downward pressure on overall economic output.

That's exactly what happened in Japan.

It's a subtle and secular trend change.  Part of the fantastic economic growth in the U.S. since the 1970s was a combination of BOTH favorable overall demographics (i.e., more working age people as a percentage of the overall population) and increased participation in the labor force by women.  Today, we are seeing both trends reverse, with the Baby Boomer demographic shift accounting for the long term decline in working age people as a percentage of the labor force and, ironically, men who would like to work will increasingly be displaced from the workforce because of offshoring of low-skilled manufacturing jobs.

It's just bad luck that we happen to be on the threshold of this demographic shift (and the accompanying economic headwinds it represents) at the same time that we are working through the aftermath of a financial crisis.

A demographic shift will impact an economy for a generation, while a financial crisis will normally impact an economy for 5-10 years.  What happens when they overlap one another?  Probably a few pretty miserable years, starting in 2008, and probably easing up a bit around 2014, but staying pretty un-remarkable through the mid-2020s.

Unfortunately, I think the scenario above is the best case.  History has all sorts of examples of bad demographics and financial crises leading to much worse outcomes.

In my view, the three events to keep on your radar going forward are currency crises, natural resource bottlenecks (either political or geological) and solar storms.  In my view, these are the events with the potential to create the most additional havoc on top of what's already going on.  A bad solar storm-driven EMP event in particular would be like something out of a movie.

[LNGTERMER]

MT you just lost me with the solar storm EMP  :D. Is'nt that one of many unlikely events that might lead to similar outcome. I can think of a meteor hitting the planet for instance. I think you are right though on the combination of the demographic shift and the ongoing offshore job shipping that many of our corporations are engaging in for cheep labor will lead to the decline of our standards of living. This combination of manufacturing the goods over seas and importing them back to us for purchase allows companies to buy low and sell high but they are shooting themselves on the foot in the long run since our consumers will be priced out of them due to declining income.

[MediumTex]

MT you just lost me with the solar storm EMP  :D. Is'nt that one of many unlikely events that might lead to similar outcome. I can think of a meteor hitting the planet for instance.

It is different from a meteor in that I think that from a geologic time perspective these solar storm events happen far more frequently.

Also, meteor strike type events are basically not something that could be mitigated through preparation, so it's probably not worth worrying about.  Solar EMP effects could be mitigated through hardening the electrical infrastructure of the world (though that would be no small task).

Read up on the 1859 solar storm event and think about what such an event would do today with virtually every aspect of modern life being facilitated by layers and layers and layers of electrical devices and circuitry.

http://en.wikipedia.org/wiki/Solar_storm_of_1859

It sort of teases the imagination.  Things like cloud computing all of the sudden don't seem like such a good idea.  It's probably not worth getting upset about, but it's definitely worth thinking about.

[Storm]

Interesting.  The Mayans actually were impressive astronomers and tracked the solar cycles with a great degree of precision.  What is fascinating is that the radiation from the Sun affects almost all life on earth in some way or another.  Another interesting observation is that from time to time the magnetic poles of the earth reverse and magnetic north becomes magnetic south.  One of the predictions is that when the Mayan calendar ends in 2012, the earth's magnetic poles will reverse again, which would wreak havoc on a number of climates and especially animals that use magnetic fields to navigate such as birds.

There are at least 8 or 9 different doomsday scenarios that might cause human life to revert back to an agrarian society.  Let's hope none of them ever happen, but be prepared in case they do.

[Storm]

Another interesting graph from the Fed:

http://research.stlouisfed.org/fred2/series/CMDEBT

Household Credit Market Debt outstanding.

This graph shows we have yet to deleverage.  That should be 8, or 9 trillion, maybe 10 tops, but it ballooned to 14t during the housing bubble.

My prediction is that BofA and possibly Citi will need another bailout before this is all over.  That chart shows me that they still have all of those bad loans on their books.

This also points me to QE3, QE4, etc, as the Fed tries to keep that number from falling to where it must fall.

Deleveraging leading to deflation... The cycle continues...  There is no way the Fed can blow another bubble to inflate their way out of it.  All they can do right now is try to cause enough inflation to counteract the deflation, which never works.

[MediumTex]

There is no way the Fed can blow another bubble to inflate their way out of it.  All they can do right now is try to cause enough inflation to counteract the deflation, which never works.

Like spraying a fire hose into a tidal wave...it's a token gesture to say that we tried to ease the damage.  For those who believe it is anything more than a token effort, they are either ignorant of the underlying forces at work or delusional about their own abilities to alter the course of events.

I think that the Japanese experience provides a wonderful example of this process at work, especially the delusional part.  I imagine a modern version of one of those old Godzilla movies with the Japanese emergency workers running around frantically as Godzilla stomps through the city...except the emergency workers are Japanese central bankers and Godzilla is deflation.

[Wonk]

MT,

I think your scenario stands a >50% chance of playing out.  The amount of credit destruction is incredible.  I think the most successful scenario The Fed can hope for is to continue to keep asset values elevated while creating an orderly devaluation over the next 5-8 years.  This would resemble a 70's style stagflation.

You could make the case we've already been through 10 years of a 70's style stagflation with little real growth in the overall economy.  We have succeeded in diminishing the purchasing power of most world currencies over the last 10 years, but we have not succeeded in creating real, inflation adjusted values in productive assets.

One of two things has to happen for the system to clear:

1. non performing debt has to be recognized and liquidated, allowing assets to fall and reach a market-based bottom, or

2. the currency used to price assets needs to be devalued, allowing asset values to stay high in nominal terms while destroying the real value of the underlying debt.

Of course right now we don't know what will happen--which is why the future is uncertain.  But I would imagine some combination of the two is the highest probability.

[Storm]

Another thing to point out, when looking at the consumer debt outstanding.  It currently sits at around $13.9 trillion.  If it normally should be $10 trillion, tops, and the big banks have a combined market cap of around $500 million, doesn't that mean the banks are completely insolvent?

How can they carry ~$4 trillion of bad debts on their books when they are worth less than that?

This is zombie banks all over again.  Japan 2.0.