Where is all that MONEY going?
The economy shows signs that it has stopped from falling and markets are up sharply from their low earlier in the year.
Does this mean the crisis is over?
In my last blog “Is this Crisis Over?” you can read about a few reasons why that is highly, highly unlikely. And there is more…
Good friend and brilliant economist Jim Walker has just published an article that brings evidence to the dynamics I am describing in “Eye of the Storm”.
Dr. Jim (as he is lovingly called in the investment community) explains and shows that all that money created by the FED since this crisis started (approximately $2 trillion) has immense trouble finding its way into the real economy but instead sloshes around asset markets, pushing up asset prices.
Despite a more than doubling of base money since early 2008, the US economy has not found any traction and continues to contract. Jim shows that the transmission mechanism is broken. The creation of M1, which is the base of money influenced by central bank action is not even translating into growth in M2, which includes parts of the private sector’s decisions in uses of money.
Thus, as expected, the Fed is creating a lot of liquidity that does not translate into economic activity.
Loan growth is (and will remain for some time) negative.
One of the key characteristics of this crisis is that it was built on credit. The levels of credit outstanding are unprecedented and unsustainable. The FED continues to believe that creating base money will eventually restart the credit mechanism. I agree, but the cost is very high, in particular for main street. The Fed will have to print a lot of money. Its balance sheet has been expanded to approximately $2.5 trillion. This compares to a total US debt outstanding of $50trillion. All the additional money has been doing was finding a way to become profitable, and no matter what the Fed would like it to do it is not finding its way into the real economy and thus needs to flow into asset markets.
This is evidence that the US economy is not nearly as sound as markets and media are portraying. Markets are celebrating the end of the crisis with taxpayer’s money while hardly any of it is flowing into the real economy. In the meantime still sound businesses and most of all smaller local banks will be watching their loan books deteriorate on falling commercial property and a generally worsening business environment.
These banks and businesses we thought safe and sound because they didn’t engage in all the fancy financial engineering are going to be hit hard in the next round of collapse.
Unfortunately, international dynamics are exacerbating the situation… but this is a subject for another letter.
Category: Eye of the Storm, Monetary Policy, financial Crisis | Tags: AIG, Alan Greenspan, bailing, Banks, Ben Bernanke, Black Scholes, CAPM, Crash, credit, crisis, cycles, economy, FDIC, FED, Finance, financial Crisis, fiscal policy, GDP, George Bush, Goldman Sachs, government plan, Hedge funds, Henry Paulsen, Krugman, Lehman, leverage, Merrill, Modern Finance, Monetary Policy, Morgan Stanley, property market, securities and exchange commission (SEC), Shadow banking, sub-prime, Taleb Nassib, TARP, Tim Geithner One comment »
November 22nd, 2009 at 5:26 am
Problem is the credit and the leveraging of the individual and the interest rate which are moved by the central bank.
If you look at the american economy, they reduce the interest rate from 5.25% pa. to 2% and that boomed the economy. Mean that people could borrow more money to spend. Suddenly in all wisdom of inflation, the fed moved the interst rate from 2% to 5.5%. Literally making all the overleveraged people to incapable of paying loan leading foreclosure and distress sell.
during the distress sell the interest rate are high and nobody had money to buy and too many property on the market forced the prices to crash.\
When the property prices crashed the bank’s looked upon the cds writer for money and they had also overleveraged which lead to the collapse of the empires.
In hindsite, fed could have allowed the inflation to continue rather than getting into this cascading mess.
I would not know why nobody questions the era of consumerism by leveraging. Bank have to increase the margin of the loaner and the interest /installments to his income number
That will lead to paced growth rather than a fiz.