This is one of my oldest posts I have been able to locate. I believe it was January or February 2001 I started writing online. It was posted on this site:
2/24/01 5:54:40 AM
214 reads 1 reply
My friend, you like most Americans seem to be ignorant of how credit works. Inflation is something that cannot be measured by prices because it happens outside of prices, upon the extention of credit. What price will clear the shelves is always the important price and it generally collapses over time because people run out of credit. Hyper inflation is generally created in a system where there in noncollateralized debt being extended. Eventually the amount of debt against collateral becomes sufficient to begin to consume money rather than produce it. At that time, there either has to be more assets to mortgage and get more money or the ability to service the debt begins to decline, thus impairing the loan against the
property. If a lender begins to sustain losses, they lose the ability make more loans and become financially impaired. If you read closely what Doug Noland prints, you will see that fine line between
inflation and deflation.
The inflation we suffered in the 1970's was as much or more a result of debasing the American dollar than merely printing too much money. A shift in demographics also contributed to a lot of shortages as did spiraling regulation. Plus, the very reason for the debasement of our money was the Great Society, where a tax spiral was created and a lot of the debt was monetized.
There are two things at work right now and not many people understand them. One is what Noland talks about and that is the creation of deposits outside of banks. The problem with this system is there is little control on how far they can spiral these deposits, as long as someone can find the collateral to borrow against and there is paper to support the deposits on the other side of the equation. This system would
work fine, but there are now increasing chances the quality of the paper behind these money market assets will go bad and if they do, there will be a run started on these funds. All the money in this country is in the banks and these money market funds have to draw on this money in some way or another. So
they are supporting a tremendous amount of close to cash deposits with really no money. Have a run on these funds and the value of the paper implodes on itself. Its kind of like the Mississippi bubble where the Mississippi stock collapsed when John Law offered warrants to buy the same stock. The system becomes a vacuum, short term rates go to the moon and the capital base of FNMA implodes on itself. You take
FNMA out of the mortgage market and there is not a mortgage market. Try to borrow funds or sell your house without a FNMA or any system where there is a low down payment necessary. This knocks over every domino and the life savings of the entire country goes up in smoke.
You may think this isn't possible, but it is becoming more probable every day. The problems in Japan revolved around real estate and excessive lending on it. I was in the mortgage business in the 1980's and we would kick what they call a good borrower today out in the streets. The quality of loans today are crap. Despite the higher quality of lending in the 1980's, the market still imploded here. Virtually all equity in homes sold at full financing after 1979 was gone and there were close to 100,000 foreclosures here. It won't take much of an economic slowdown to wipe out almost all the equity in homes in the United States due to this excessive lending. That is why Noland calls it a moral hazard and a problem in the future. The
collateral value will collapse when the financing dries up and the equity, what enables people to move in the first place, is gone.
Then there are the banks. This outside the bank financing has diminished the quality of bank loans. If the banks have their capital impaired in a slowdown, which is likely, they don't make new loans. When money is paid back to a bank, it ceases to exist in anyones account, not even the banks. M-1, which is hardly sufficient to support what is going on now without repeated crisis around the world could potential
and probably will implode as this asset deflation continues. Robert Prechter said it best when he stated we were a credit based society and that the extention of credit was based entirely on the good faith of the parties. The faith of the lender the loan was good and the faith of the borrower that they could pay it back. If you have so little knowledge to think the money market assets in these accounts and the
payments made against loans behind this commercial paper will be made in event of a collapse in M-l then you need to do some studying. People start pulling in their horns when times start getting tight. They sell off assets and pay off debt, thus constricting the money supply. Then a lot of the other debt becomes unservicable and the system implodes. It's part of a bubble deflation.
I heard in Thailand a plane was bought with a Krugerand as was an almost new BMW. Now is that inflation or deflation? You want to sell something of value in a declining market and you will wonder what happened to inflation. The point is, all this paper piled up on top of the banking system is going to implode. People can move their money to the safety of banks, but banks have got to purchase this paper
to give them the money so they can get it out of these accounts and put it in the bank. Banks won't be up to buying these assets in a liquidity squeeze unless they can get favorable terms and borrow from the fed at rates that make the paper worth the risk. The rates the Fed charges are useless if the banks don't make
loans and borrow the funds, collateralized of course, from the Fed. People seem to be under the assumption the Fed just throws out money on the street. If lending and borrowing dry up, the discount rate used by the Fed doesn't matter.
Real estate price in Japan are now 10 cents on the dollar and I have heard estimates they still have another 90% drop in front of them. Their central bank has had rates almost free, yet it hasn't picked up the economy much. Remember, this country thought times were bad when their unemployment rate went up to 4%. Their problem is their asset bubble burst and they cannot get collateral to create more money.
They just flat ran out of collateral in the 1980's. It takes money to provide liquidity to the markets. We are going to find this out quick as this declining stock market starts to suck hard cash out of circulation.
The asset bubble bursts all the way down when it bursts. Most people in the US don't have enough money to live 2 months without a job and they will surely use what credit resources they have left. There will be people with maxed out credit cards and others paying them off monthly and all that will be left in these money market funds are debts with no mathamatical solution. Try to draw your money out of a
nonperforming money market fund and see how far you get. There is sure to be a run on these uninsured accounts and there will be no market to liquidate several trillion dollars in short term assets in these funds. So, when the credit system in a credit based society collapses, there are no spendable funds in widespread circulation, thus no money to buy goods and services and a massive deflation. The wholesystem is built on a flimsy house of cards and a small breeze can now topple it. The inflation you are speaking of is in the past and we may have more in the future, but Greenspan can only fight one tiger at a time and he knows the deflation tiger will win this battle, even if the inflation tiger appears to be winning
right now. He takes an eye off the deflationary threat for one minute and we are dead ducks. But, I don't believe anything less than the government creating money off treasury debt is going to stop this beast. No credit, no money, no sale.