This is an Extraordinary Time

SUBHEAD: We have two economies - the simulacrum one of stocks soaring, and the real one of earnings and hours-worked plummeting.

By Charles Hugh Smith on 22 June 2013 for Of Two Minds -

Image above: Illustration of for article on Casino Banking in The Freeman. From (

It's as if we have two economies - the simulacrum one of stocks soaring and the real one of earnings and hours worked plummeting.

It is difficult to justify the feeling that we are living in an extraordinary moment in time, for the fundamental reason that it's impossible to accurately assess the present in a historical context.

Extraordinary moments are most easily marked by dramatic events such as declarations of war or election results; lacking such a visible demarcation, what sets this month of 2013 apart from any other month since the Lehman Brothers' collapse in 2008?

It seems to me that the ordinariness of June 2013 is masking its true nature as a turning point. Humans soon habituate to whatever conditions they inhabit, and this adaptive trait robs us of the ability to discern just how extraordinary the situation has become.

In my 59-year lifetime, the dramatic, this-is-history-happening moments are obvious: the Kennedy assassination, 9/11, and so on. Other tidal changes developed over a period of months or years: Watergate, which ballooned from a minor break-in to a constitutional crisis, is a good example. So is the financial meltdown of 2008, which actually began back in 2001 when the Federal Reserve chose a policy of super-low interest rates and super-abundant liquidity to lessen the post-dot-com recession.

I have an unavoidable sense that May-June 2013 is the high water mark of the political/financial response to the global financial meltdown of 2008. Nothing systemic has changed in the five years; the status quo financial and political systems have made cosmetic reforms, but the power structures have not changed at all.

The status quo has simply ramped up its traditional policies: since lowering interest rates didn't spark a strong recovery, then lower rates to zero, and so on: more money creation, more credit creation, more bond purchases, more subsidies for housing, more transfers of private debt to the public ledger--more of what has failed spectacularly.

That's what marks June 2013 as extraordinary: the Powers That Be have gone all-in. If their policies fail to ignite a self-sustaining recovery in the real economy, there are no policy options left.

Those who don't follow finance might not have noticed the extraordinary nature of recent financial events: Japan's stock market rose by 75% since December before reversing sharply, the U.S. S&P 500 climbed 24% in 2013, gold crashed by over $200 in a matter of hours, and the Japanese yen has lost a quarter of its value (in U.S. dollars) in a matter of months.

None of this makes sense in terms of the real economy: U.S. corporations didn't suddenly become 25% more profitable; Japan's economy did not expand by 75% in five months, and none of the fundamentals in the value of gold suddenly changed overnight.

These rapid, gargantuan fluctuations are disconnected from the real economy. This in itself is extraordinary. The financial press explains these bubble-like advances and collapses in terms that only make sense to financiers: the yen-dollar pair, the yen carry trade, etc.

That complex, abstract financier policies and trading strategies now dominate stocks, bonds and precious metals is also extraordinary.

I have endeavored to understand the fundamentals behind these wild fluctuations proposed by the media, and have concluded none of it makes any sense in conventional economic terms. To mention just one example: gold has traditionally been viewed as a hedge against inflation. Gold's collapse is being attributed to lower expectations of inflation. OK, so there's no inflation, ergo, the global economy is in slow-growth/no-growth mode, hence no inflation. Then what is powering global stocks higher? We're told "an improving global economy" is the driving force, but the data on this supposed recovery is mixed at best.

Some observers claim gold dropped because the yen dropped and the U.S. dollar strengthened, but a glance at the 10-year chart of gold and the dollar quickly disproves any correlation: gold rose when the dollar dropped and when it rose.

This is another extraordinary thing about the present: none of these moves make any sense. Pundits and analysts are seeking explanations after the fact, postulating correlations as causes with little historical backing. It's as if the financial media is incapable of confessing none of this makes sense, and instead the media piles one complex explanation on top of another to justify what is clearly an extraordinary disconnect between the real economy and asset valuations.

Bottom line: even if the global economy is improving (and there is ample evidence that data is being juiced or manipulated), it isn't improving enough to justify stocks rising by 25% to 75% in a matter of months.

Real estate is also back in bubble territory, in those markets with plentiful capital and limited inventory: we're back to bidding wars and dozens of people competing for the right to buy an ordinary home.

The bond prices of fatally insolvent European governments have fallen, as if these economies have suddenly been restored to health and fast growth by European Central Bank (ECB) intervention. European stock markets are roaring higher as well. Neither makes any sense in terms of traditional risk-pricing, price-earnings ratios and so on.

We are living in an extraordinary global financial experiment, in which financier tricks (zero interest rates and massive injections of credit and liquidity) have been pushed to their red-line limit in the hopes that these extraordinary measures will finally, after five long years, trigger a self-sustaining expansion of the real economy.

Those in charge of the experiment are constantly reassuring us it has already succeeded. I think the data shows the experiment is in the final blow-off stage in which the beaker full of toxic ingredients is bubbling with dangerous vigor.

There is one last extraordinary feature of this time: the data "proving" the experiment is successful is self-referential: drop interest rates to zero and subsidize housing, and voila, you get a surge in building permits. Take one full-time job and turn it into 1.5 part-time jobs, and voila, the unemployment rate declines and the number of jobs increases.

Then take these metrics (higher permits and jobs), weigh them heavily in your measure of leading indicators, and then declare the leading indicators "prove" the recovery is self-sustaining.

All this leads to a question: what would happen to the economy if all the financier tricks were stopped, and the price of risk, credit, assets, etc. were discovered by the marketplace?

It's as if we have two economies: the simulacrum one of stocks rising 75% in a few months, and the real one of household earnings (down) and hours worked (down). Eventually these two economies will have to merge into one. I sense 2013 will be the critical year when the schizophrenia is resolved one way or the other.

Financialization, Debtocracy, Diminishing ReturnsSUBHEAD: Every asset (housing, bonds and stocks) that depends on cheap  abundant credit is doomed.

By Charles Hugh Smith on 20 June 2013 for Of Two Minds - 

About a month ago I asked What If Stocks, Bonds and Housing All Go Down Together? (May 24, 2013). Why would such an outrageous thought even occur to me?

Four words: financialization, debtocracy, diminishing returns. The entire global economy, developed and developing nations alike, is now dependent on cheap, abundant credit for everything: for "growth," for asset inflation, and ultimately for central state deficit spending, which props up all the cartels, rentier arrangements, fiefdoms and armies of toadies, lackeys, apparatchiks and embezzlers that suck off the Status Quo.

I have long endeavored to explain the harsh reality of neofeudal, neocolonial financialization: Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012) and the neofeudal debtocracy that depends on low yields (interest rates) to enable enormous deficit spending: Why Krugman and the Keynesians Are Lackeys for the Neofeudal Debtocracy (April 24, 2013).

The wheels fall off the entire financialized debtocracy wagon once yields rise.There's nothing mysterious about this:

1. As interest rates/yields rise, all the existing bonds paying next to nothing plummet in market value

2. As mortgage rates rise, there's nobody left who can afford Housing Bubble 2.0 prices, so home prices fall off a cliff

3. Once you can get 5+% yield on cash again, few people are willing to risk capital in the equities markets in the hopes that they can earn more than 5% yield before the next crash wipes out 40% of their equity

4. As asset classes decline, lenders are wary of loaning money against these assets; if the collateral for the loan (real estate, bonds, stocks, etc.) are in a waterfall decline, no sane lender will risk capital on a bet that the collateral will be sufficient to cover losses should the borrower default.

Let's take a look at four charts about housing and household net worth. For the middle class, the home remains the key asset, so housing and household net worth are correlated.

Since 1970 mortgage rates  rates were pushed to 17+% to snuff inflation in the early 1980s, and they've dropped over the past 30 years to historic lows: the rate for a fixed-rate 30-year conventional mortgage was about 3.5% a few weeks ago. It has now risen above 4%.

In the golden age of growth from 1991 to 2002, mortgages rates bounced between about 7% and 9%. The band from 1970 to 1979 was about 7.5% to 10%.

In other words, in eras of strong growth and low inflation, mortgage rates have been around 7% to 9%. So what happens to the monthly payments when the mortgage rate doubles from 4% to 8%? The monthly payments rise by about 54%. And what happens to the price of houses when rates double? They fall to the point that households borrowing money at 7.5% - 8% can afford to buy a house, i.e. a price much lower than today's Housing Bubble 2.0 prices.

If mortgage debt had expanded at the previous rate, total debt would be closer to $5 trillion instead of $10 trillion.

When debt becomes cheap and abundant: debt rises faster than wages or assets.

But hasn't household wealth increased mightily in the past decades? Here is a chart that plots the relationship of household net worth and total credit owed, i.e. debt:

Household wealth may be rising, but what this chart reveals is debt is rising even faster--that's why the line is declining. Put another way, every dollar of new debt is generating less and less wealth.

You might think that The Federal Reserve's policy of making credit cheap and abundant would goose people to consume and invest more money. Alas, the velocity of money is hitting historic lows: the Fed may be creating credit but people and enterprises aren't putting that money into circulation.

It's called diminishing returns: every dollar of debt creates interest payments, but it's no longer doing households or enterprises any good. The Fatal Disease of the Status Quo: Diminishing Returns (May 1, 2013).

That's why all asset classes that depend on cheap, abundant credit are doomed: once yields/rates rise, the valuations of those assets implode. And once valuations implode, there's not enough collateral left to support the loans used buy all those cheap-credit-inflated assets. So the financial system also implodes.


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