Credit expansion has gone way past the point of diminishing returns...
THE FEDERAL RESERVE'S efforts to revive the economy are failing, writes Fred Sheehan for the Daily Reckoning.
The Fed is failing because of the four topics that never enter the mind of Federal Reserve Chairman Ben Bernanke: money, credit, leverage, and capital.
The productivity of capital is an important consideration, one which most people understand, in their own words. A bank does not lend money to a business that cannot earn its way to paying back the loan.
A potential borrower understands the banker's hurdle. Similarly, an investor buys shares of common stock in a company that will produce the most from the least. The higher the profits produced per share, the more the shares should be worth.
In other words, most folks understand the classic connection between risk and reward. And most folks also understand that merely borrowing more money, without putting that money to productive use, will never solve anything.
Ben and friends do not think this way. They believe that funneling more credit into the economy is a surefire means of "kick starting growth." But the facts say otherwise.
During the quantitative easing programs, the Fed's credit-from-the-heavens produced zero growth.
During the 1980s, the change (rise) in non-financial domestic debt divided by the change (rise) in nominal Gross Domestic Product was 2.2. That is, for every $2.20 borrowed, the United States produced $1.00 of additional goods and services (nominal). In the 1990s, debt was less efficient. The US borrowed $2.70 for every $1.00 of growth. More recently, between 2001 and 2008, this ratio soared all the way to $4.20 for every $1.00 of growth.
In other words, every incremental unit of credit has been less and less productive. But that's the only tool Bernanke has in his toolbox, so he just keeps using it. Since the Fed rolled out its various quantitative initiatives in early 2009, the ratio of debt-to-production has been 3.7:1 (through June, 2011). But, the increase in transfer payments (1-in-7 Americans now receive food stamps, Cash for Clunkers, shovel-ready bank bailouts) exceeds the rise in nominal GDP by a wide margin. Thus, as a measure of financial efficiency, the ratio is now meaningless.
The additional debt being manufactured is not producing any additional goods and services. The more Bernanke applies his senior thesis to the real economy, the less the economy is able to pay down old debt, much less manufacture additional goods and services to pay down the new debt.
The Fed has pegged short-term interest rates at zero; Operation Twist is an attempt to drive long-term rates to zero (or, close to it); the rise of incomes in the United States since 2008 has been zero; "real" GDP growth since QE1 has been less than zero; the FOMC is an absolute zero.
Physical elements tend to behave very strangely as they approach absolute zero (-273 Celsius).
Economic elements, as it turns out, are not so different. The move toward "absolute zero" along the yield curve is producing some very strange behavior — in both the financial markets and the economy at large.
The Authorities have lost control of the markets they have been manipulating. Desperate tactics, with untold unintended consequences, such as the Swiss National Bank doubling its monetary base last month, ensure more fanatical outbursts from the Fed, the ECB, and the Bank of Japan.
In this setting, gold fell more than $150 last week. Strange, isn't it? Other than remote islands, gold is the best bargain around.
Get the safest gold – stored in your choice of London, New York or Zurich vaults – at the lowest prices with BullionVault...