Quantum Pranx


Austerity and Critical Mass

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from Ancient America
Posted May 17, 2011

Some say that QE3 won’t happen. The U.S. is done with stimulus and force-feeding liquidity and inflation down the world’s throat. Okay, it’s austerity then. How much austerity does anyone think we’re going to have here in America? What is the critical mass and when will we reach it? How much inflation can our creditors handle before they reach their critical mass and have to allow rates to rise? Paradoxically enough, the real question has become ‘can we afford austerity’? I believe the answer is ‘not anymore’. Due to relatively recent events, austerity has become a mathematical impossibility.

QUANTITATIVE EASING IS NOT TECHNICALLY “MONEY PRINTING”. However, it did accomplish scaring everyone out of dollars and into “riskier” assets. So, while we didn’t print much, emerging economies certainly did as people ran screaming from the U.S. dollar. The result of which has been rampant inflation all over the developing world and near parabolic gains in commodities and equities. We’re left now with a dangerously deflating economy here in America while our creditors are heavily overheated. Not many people have much confidence in what QE or stimulus have accomplished. Our banks have fresh new reserves they can’t and won’t lend while our employment picture remains increasingly grotesque.

With QE2 ending, negative real interest rates and emerging markets unable to afford more inflation, how does the future look for U.S. government bonds? When rates rise, what of the outlook for equities and for the economy as a whole? If the economy stalls and people want to hold onto their precious cash, business will suffer and who will fund our local, state and federal governments? If our government programs can’t function, and people start to worry about their grandmothers, their pensions and their grandmothers pension, what will happen? Austerity? Not over our Masters of Debt’s (MOD’S) dead bodies! But when will we reach critical mass?

Why will congress and the fed absolutely intervene? When you figure it out, it seems almost comical to have ever believed otherwise. Simply put, that’s their nature. Nowadays, it’s what they are designed to do. Given current events, they truly have no choice whatsoever. Did Volcker raise rates way back when? Yes. Are they sort of attempting austerity all over the world? Well, kinda. But that’s not what’s  happening here and now. It won’t happen…not for long. Tightening might come from the emerging markets, but not from us. Just as credit card addicts rarely cut themselves off, we’d sooner end this easy money regime as collectively give up cheap oil. In severe debt situations,  the creditors usually do the tightening, not the debtors. What environment will that conflict produce? When congress and the fed stimulate, ease and shuffle around assets and liabilities in a compounding vortex of fear and arrogance, how will our creditors react when they don’t have a choice anymore?

The first point of critical mass will be when the austerity is no longer tolerable for the government. The second is when emerging markets are forced to let their currencies appreciate. The critical question is whether this can occur in an orderly fashion or not? I think not. Our economy is so over-leveraged that austerity simply isn’t an option. There was a tipping point where the cost of providing tolerable austerity became too expensive for the world to afford. That is the main concept to understand. The bizarre fact is that we couldn’t financially achieve a hard money stance if we tried. Unfortunately, this is a somewhat recent development.

The fed’s dual mandate of stable prices and maximum employment is impossibly vague and ridiculous. What are prices? What is employment? Who’s prices and what work? Defining either requires shoving a qualitative square peg into a quantitative round hole. This is why no one believes in any of the models that the fed uses. Metrics such as the CPI, PPI and BLS numbers are useful tools but create a disconnect when applied to “monetary policy”. Fiscal policy has the same fallacy built into it. However, unleashing free market forces upon interest rates currency valuations would mean a complete restructuring of the global economic matrix.

If the fed lets rates rise, payments become too onerous for everybody here. If they continue buying treasuries, emerging markets get inflation and we all get asset bubbles. These inflated economies cannot allow us to do that but if rates rise too quickly emerging markets immediately lose their biggest customer without a significant consumer base established in their own countries. Therefore, QE3 will look very different than QE2. In reality, there are all kinds of back door attempts at stimulus being performed right now. These have been well documented by many pros such as Meredith Whitney, Bill Gross and Zerohedge.

The real issue here is public opinion. Obviously, the giant auction house that is our global market place is an organic amalgam of emotional organisms clawing at each other for some profits. People dictate policy, not economic models and while Bernanke may believe that a stronger CPI and 9% unemployment means one thing, it actually means another thing. The more people hear about the CPI and unemployment data, the angrier they get and the stronger their stance gets against austerity. However, everyone is concerned about debt. America is awash in it. Some believe that we aren’t at a breaking point and that we can mathematically sustain another 5-10 trillion dollars in debt. Whether that is true or not, public opinion is that our national and consumer debt is a ticking time bomb.

So, which will prove the greater inertia: fear of a national, possibly global debt explosion or fear of austerity and deflation. Many could stop reading this right now as I believe the answer is inherently undeniable. However, I will continue briefly.

The elite hedge fund managers, bankers and policy makers have the ability to profit in any environment. Whatever combination of inflation, deflation or hyper-reinflationary price deinstagflation we get, they are positioned to prosper. However, because of capital flows and velocity, inflation benefits them the most simply because they get to use the money first. The argument that inflation harms big financial institutions’ balance sheets and that they would benefit from higher interest rates is incorrect. Deflation slowly kills their balance while inflation gives them a flow advantage. This being said, they aren’t the only game in town.

If congress and the fed were to enforce austerity, the outcome would be unpredictable to say the least. When and how would we reemerge after a decade of gut wrenching deflation? Is it not possible that given the choice, many citizens might willfully opt for hyperinflation? I could see many possibilities in which hyperinflation would actually be better for a lot of folks. Hyperinflation is only one possibility anyway. We could have a Japanese style deflation-inflation cycle for twenty years. I think that’s doubtful given the compounding black hole of debt and the public opinion regarding it, but Mish thinks it’s likely and I like Mish. In any event, the unpredictability of a hard money policy juxtaposed with that of an easy policy definitely favors the likelihood of the latter. When any attempt at austerity reaches the point of critical mass where the pain of a credit crunch overtakes the fear of hyperinflation, get ready.

In conclusion, when esoteric conjecture hits the cold hard wall of human suffering, emotion always wins. Austerity is mathematically impossible given that no one at the top benefits from it and no one at the bottom can psychologically bear it. Emerging markets may try to force rates higher, but only as much as its benefits outweigh its harm. In the end, organic responses will rule the day and the over-leveraged nature of our global economic environment ensures that the cheap money spigot cannot be closed without a complete restructuring. So, get ready for a transitory bout of tightening followed by a continuation of U.S. currency debasement and asset bubble formation.


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