Deleveraging – A Balance Sheet Recession

Posted on January 2, 2012 by Henrik

deleveraging Deleveraging A Balance Sheet Recession

After a short break we are back at work at the Capital Research Institute (CRI). The world economy is continuing to try to shake off the 2008 financial crisis, Europe is still in big trouble with no end in sight and the US is quietly trying to maintain stability and solvency. Since no real improvements have been made during the last years we cannot expect things to get better for the long term, short-sightedness is what modern politics is driven by since nobody can guarantee to be re-elected, thus making plans for more than 4-5 years is unrealistic since everything could change after the next election. During the last few month we have stated our beliefs that the US as well as Europe are on the same track as Japan was during the “Lost Decades” through which zero interest rates policies (ZIRP) were maintained for many years to provide funding to insolvent zombie banks and corporations.

The Lost Decades resemble what we call balance sheet recessions due to deleveraging of the financial system. Europe and the US will go through the same deleveraging process during the next five to ten years. Corporations, banks, and households have borrowed too much money in order to invest in various derivatives and real estate. For example, when AIG started to have trouble in 2008 the hedge fund responsible for those massive derivative bets only made up about 3% of AIG’s balance sheet, yet due to the excessive leverage of the fund it almost took down the whole company. A leverage of 33 to 1 means that a 3% change in the value of the investment would wipeout close to 100% of the equity. A leverage of 30:1 is more common than one might think, which is like a kid playing with fire. Since banks and institutions are not willing to lend at the moment as nobody knows what toxic assets the others are holding, companies are forced to pay off their existing debt due to lack of available funding.

With companies paying off debt and therefore decreasing their leverage reduces growth opportunities, which leads to a balance sheet recession. The Lost Decades were caused by balance sheet recessions for the same reason. Deleveraging happens during times when asset bubbles burst such as the US housing bubble and the underlying assets become worth less than the equity left in the investments, at which time investors sell the assets and pay off the debt. Deleveraging is also the reason why the by so many expected massive inflation due to QE has not realized, since the extra liquidity in the system is offset by the reduction in leverage by corporations and individuals.

What is counter-intuitive to most economists is that companies should not pay down debt with ZIRP, meaning there is no better use for the money even at zero interest than to pay off debt which costs the companies almost nothing to begin with. The reason why companies would pay off debt with ZIRP is that the balance sheets are under water due to excessive leverage during the bubble period. At the micro level it makes sense for companies to pay off debt to balance their finances again, but at the macro level when everybody decides to pay off their debt during ZIRP means massive deleveraging since these companies would otherwise be bankrupt even at zero interest.

As many of our newsletter subscribers know, 95% of money is created by private banks, but when households and companies decide to pay off debt, the money multiplier effect is cut short since private banks cannot lend out deposits at a multiplier. Without available funding for further investments, asset prices will fall such as we have seen in housing prices. If we take a look at what happened to real net worth per capita we can see that in the US the blowing up of the housing bubble has caused a dramatic drop in per capita net worth. It is interesting to note that prices leveled off at a level before the housing bubble started in 2000, when Greenspan tried to paper over the blowing up of the dot com bubble. This is similar to what happened in Japan during the Lost Decades.

6a00d83451b33869e2014e894bdc0d970d 800wi Deleveraging A Balance Sheet Recession

Based on the understanding of deleveraging and balance sheet recessions, austerity will not work unless the private sector is maximizing the use of cash and has healthy balance sheets, which we know is not the case in Europe and the US. Planned austerity measures will only fuel the recession. If we look at real per capita liabilities in the US, we can see that they have steadily decreased since the financial crisis, illustrating the point that the private sector is deleveraging by paying off debt. Without investments and better use of cash by the private sector, unemployment will stay high since companies are not growing and hiring. Even though we don’t belief in excessive stimulus and taking on more debt, in this case more stimulus is needed in order to maintain stability in aggregate demand, if that is the wanted outcome to keep GDP from collapsing. Others may argue let aggregate demand and therefore GDP collapse for a massive recession and possibly depression in order to fix the broken financial system to eventually implement a newer more stable system. Both sides of the argument can be taken and each comes with its pros and cons.

So what should be done? That is a difficult question and will take some creative thinking in regards to economic theory hybridization. As we have previously mentioned we belief that new economic theories are needed, short term stimulus is acceptable in order to keep aggregate demand stable to keep the economy from collapsing during a period when a massive asset bubble bursts, on the other hand stimulus needs to be controlled and normal recessions should be embraced. Austrians and Keynesians need to sit down together and draft new hybrid theories in order to have well thought through economic theories. Yet a balance sheet recession is different in that it is caused by deleveraging of the financial system. As the graph shows, US real per capita liabilities have significantly decreased since the recession due to the private sector deleveraging.

6a00d83451b33869e20154332bd5dc970c 800wi Deleveraging A Balance Sheet Recession

We belief that the FED and ECB will implement further stimulus. The central banks have little choice but to pump more money into the financial system to keep GDP from collapsing, even though the economy will further get worse and worse unless the private sector finds better use of money than to pay down debt. There is a lot to be learned from Japan and its experience during the Lost Decades. The concept of balance sheet recessions is fairly new; at the time the Maastricht Treaty was signed the concept was not yet known outside of Japan. As we know consumption is what drives the US economy, but since the private sector chooses to save and pay off debt, consumption is curtailed and therefore leads to another recession and continuing high unemployment. The European sovereign debt crisis is far from over and with politicians willing to do anything to keep the Euro alive, we can expect can interesting financial year.

We wish all of our subscribers and visitors a Happy New Year! The year 2012 should prove to be an exciting year. Please check back with us regularly since we are back at work.

Posted in Economy | Tagged , , , , , , , , , | Leave a comment

On Behalf of the 99%

Posted on October 24, 2011 by Louis

“Rise up, be counted.
Stand strong, and Unite.”
- “Outcry“, Dream Theater

The level of financial education of the average citizen (of any nation) ranges from poor to nonexistent.  Normally this would not be a big deal.  After all, only a  rudimentary knowledge of finance and economics is required in day-to-day life.   Get paid, buy clothes and groceries, hold some in the bank for future purposes.  Plus, you can count on the media to keep you abreast of the major developments and issues.  But we are in an age of turmoil, that will see the demise of USD as world reserve currency, while former members of the (so-called) middle class will see their pensions and purchasing power steadily eroded.  And the media for the most part is completely in the dark, at best, or complicit, at worst.

The point being, people don’t really know WHAT they want, in terms of reform.  Thats why the ‘Change’ gimmick worked so well for Obama.  Because people KNOW they want change, they just want someone to tell them what will be changed, and why that will be better.  Herman Cain’s 9-9-9 plan is the exact same.  People aren’t worried about the specifics, they just know they want change.   Well, I am here to help steer the herd a little, as it were.

What is needed is the banning of usury, an end to the Federal Reserve System, and a return to Sound Money, for starters.  Usury is known to the average person in the form of: credit card debt, payday loans, and any type of loan from a loan shark.  It is characterized by high rates of compound interest.  This makes it increasingly difficult to pay off.  It was illegal in the Middle Ages.  Money could still be borrowed, but interest would be lower, and it would be simple interest, not compounding.  The Federal Reserve System is a private banking cartel that currently has the power to create US Dollars out of thin air, with nothing more than a few keystrokes.  There are many excellent sources of information regarding the ongoing deception by The Fed.  A personal favorite is “Secrets of the Federal Reserve”, Eustace Mullins.

A return to Sound Money ends the nonstop devaluation of currency by bankers and politicians, meaning people’s savings will retain purchasing power, a powerful incentive to save and invest.     Once the above has been accomplished the issue of dealing with record levels of wealth disparity would need to be addressed.  A key problem in society is that the gains accrue to a very small percentage of the population, hence the collective conscious has responded, and given birth to what we are currently witnessing: “We are the 99%”

It would be worth remembering an old country song about debt bondage and the use of scrip at this point, called “16 Tons”:

“You load 16 tons and whaddaya get??
Another day older and deeper in debt
Saint Peter don’tcha call me ‘Cause-
I can’t go…I owe my soul to the Company Store”

Speaking on behalf of the 99%, we are tired of Debt Slavery and the current incarnation of NeoFeudalism!   Ban Usury, End the Fed, Return Sound Money.  All day, all week!

Sign up for our free newsletter, and remember to check back with the Capital Research Institute, as we continue to unravel The Web of International Finance.

Posted in Economy, General | Tagged , , , , , , , , , , , | Leave a comment

Jubilee, An Idea Whose Time Has Come

Posted on October 11, 2011 by Louis

arch Jubilee, An Idea Whose Time Has Come

Forbes recently featured an article that I did not read until today.

http://www.forbes.com/sites/erikkain/2011/10/05/could-national-debt-forgiveness-help-kickstart-the-american-economy/

Could debt forgiveness kickstart America’s economy?  The answer is yes.  It is something the Capital Research Institute has previously suggested.  As suggested in the article, on its own it is not enough.  But it is a crucial step in the right direction.

Now, many people are weary of debt-forgiveness because it reminds them of the government bailouts, that it is stealing from those who lent their hard-earned savings to others.  Superficially, it is a legitimate comparison, but it does not hold up.  For one, while the bailouts helped a small group, financial institutions that by and large serve as a proxy for the richest segment of society, a jubilee would be universal.  Secondly, while the bailouts created moral hazard (the expectation that TBTF were bailed out once, so management doesn’t care if they go bankrupt again, they will be bailed out no matter what) Jubilee would be established under absolute terms, it will only happen once every 50 or 70 years.

Of course, if all debts are forgiven, the businesses (i.e. banks) that rely on the repayment of those debts will be not be nearly as powerful or profitable.  If you lent more than you yourself borrowed ((i.e. you own bonds in excess of your student loans, mortgage debt, credit card debt and portion of the national debt), then you will not be a beneficiary.  You also won’t be that bad off, though, because you will start from scratch, owing no one, like everyone else.   So the richest would stand to lose the most, and those who borrowed beyond their means would gain the most.  Unintended consequences will always exist, but by limiting the re-occurence of Jubilees the system would hopefully be fraud-resistant.  The largest property owners would benefit, and it would probably be necessary to enact land reforms of some sort.  Pensions would likely need to be looked at as a separate issue. But the overarching readjustment in wealth disparity between the richest 1% and the rest of us would be the ‘piece de resistance’.  Income for most would go up, due to less money being spent paying interest on debt.

Now what else would have to be instituted alongside a Jubilee?  Well, sound money, i.e. backed by gold and/or silver, is top of that list.  It would ensure that we don’t just enter another cycle of fiat debasement, government deficit spending, food and energy inflation run amok.  Banning usury would be up there.  Usury as defined by the CRI is high rates of compound interest.  Charging a low rate of simple interest would not be considered usury, for e.g.  This would help ensure that debt slavery is not just abolished  temporarily.

That is just what is needed from the financial perspective.  From an economics perspective, the ‘Developed World’  needs to start manufacturing again, plain and simple.  A voluntary 4 day work week would provide demand for new workers.  The point is not to have government legislate solutions, though.  The point is that society has the tools to solve its problems, if it ‘wants it bad enough’.

The greatest benefit heretofore unmentioned would be the destruction of Elite’s money creation mechanism, whereby they can create money out of thin air, and lend it to the rest of the population with interest (or to their bankster buddies, without interest, as the case may be).   From this digital gold mine does flow the power to control markets… And nations!

Surely the Jubilee is an idea whose time has come!  Thanks for checking in with the Capital Research Institute, don’t forget to sign up for our monthly newsletter, and visit us again as we continue to Unravel The Web of International Finance!

Posted in Economy, General, Gold Standard | Tagged , , , , , , , , , , , | Leave a comment

Consequences of a Trillion Broken Promises

Posted on September 28, 2011 by Louis

broken promise Consequences of a Trillion Broken Promises

Some topics require lengthy intros.  In our world of ever-decreasing attention spans I better cut to the chase.  Greece is bankrupt, hence the solution for Greece is to declare bankruptcy.  Similarly,  America is a (bankrupt) de-industrialized nation well on its way to becoming a part of the Third World.  What marks the Third World, in my opinion, is the glaring wealth disparity, systemic injustice, and widespread corruption.  Corruption American-style is just a little more sophisticated.  Rather than bribe congressmen or government officials they are merely promised cushy office jobs once their terms are over.  See?  That way you accept payment for services rendered after wards, when you are out of the public eye, out of the limelight.

The way back, logically, to a prospering economy with a growing middle class then, is to bring back manufacturing.  Until that process is initiated we will continue the current cycle of ‘recession’ and (weakest on record) ‘recovery’.

The reason for being so forward is simple.  The opinions expressed here are rarely found in the mainstream media.  Why is that, you should be asking yourself.  Who doesn’t want to see America re-industrialized, and the Greece dilemma settled in a just and fair manner?   The people who have the most to lose, obviously.  The same people who made money outsourcing the Middle Class, the people who are making money as we speak from sweatshop labor in Vietnam.  People who lent the Greek government billions, and now want everyone, any one, to take their bad debts from them.  A 100 cents on the dollar, of course.

Which is ridiculous, the antithesis to what our society claims to espouse, evolution and capitalism.  Survival of the fittest.  Keeping your winnings all to yourself also means accepting  personal responsibility for your losses.  When a society allows losses to be socialized and gains privatized it is firmly in the hands of an Oligarchy.   So who lent all this money to the Greek government any way?  Well, turns out it was the financial institutions and governments of Europe!  French banks just could not keep their snouts out of the trough.  But who are the major investors in French banks?  The financial institutions of Great Britain, United States of America, and Germany!  Well doesn’t that just spell it out for you, why ‘contagion’ will not be allowed to spread?  Why losses on Greek debt must be ‘contained’ and prevented from ‘cascading’?

So back to America.  The Fed recently announced they will buy long-dated Treasury bonds.  But wait, they are NOT printing money.  No really.  The Fed’s plan involved selling other (1 year, or 2 year) debt (and other financial instruments) and using the proceeds to buy 10 year bonds.  The market took this news, and along with the Greek crisis, went into full-on crisis mode.  The US dollar rallied, Gold pulled back close to 10%, Silver closer to 30%.  Equities sold off.  An interesting take on this is that the Fed literally went short the worldwide equities market.  They implicitly were only buying long-term debt, and they even said they would have to sell, in order to fund the bond purchases.   So did the Fed literally sell millions, billions, worth of stock (and precious metals contracts) ALL OVER THE WORLD short?  Its possible.  The truth is, we don’t have a clue what is on the Fed’s books.

I sometimes wonder if people read headlines about FullTilt Poker being a ponzi scheme, and the Greek government being bankrupt and they get it, or if it just goes over their head.  Get what, you might be wondering.

Well, there are much bigger ponzi schemes than FullTilt Poker out there, for one.  *cough Social Security cough*

And what happens to Greece can happen to America.  Bankruptcy means what has been promised will not be delivered.  Like the promises of pensions, health care, and social security payments.  To solve  a problem it must first be acknowledge.  The sooner people realize the government cannot deliver on its promises the closer we are to effectively dealing with the consequences of that broken promise.  Living in denial only postpones and compounds the inevitable pain. One way or another, the world will return to Sound Money.  Lets hope it can be accomplished in an orderly manner.

Thanks again for your time, and remember to check back regularly, as we continue to unravel The Web of International Finance!

Posted in Economy, General | Tagged , , , , , , , , , , , , , , , | 1 Comment

BiMetallic Standard, FAQ

Posted on September 9, 2011 by Louis

wealth BiMetallic Standard, FAQHere at the CRI we have been calling for a return to ‘sound money’. What does that mean? What does it entail? What does CRI think this would accomplish, exactly?

First, it is crucial to understand, as more and more people are everyday, that our current money system is dishonest and crooked. We are talking about the fiat fractional reserve system, whereby new money comes into existence when banks extend credit (out of thin air). Fiat can only be exchanged for more fiat (unbacked).
The major differences, then, under a sound money system would be in terms of where NEW money comes from. Currently private banks get to decide when new money should be created, and hence, business conditions for THOSE private banks will determine the money environment FOR EVERYBODY. This is the current situation, where banks are so illiquid and insolvent that they plainly refuse to extend credit on reasonable terms. This results in a feedback loop such as the world experienced in 2008 (when credit dried up) as well as what we are experiencing currently.

Under a gold/silver BiMetallic Standard the price of gold and silver would both be fixed. That means your salary of $30,000 would buy as much gold/silver this year as next year. The price of goods would still fluctuate, but over the long-term they would not trend higher, but rather stay flat. Obviously knowing that your money will retain its purchasing power is a powerful incentive to continue working hard, whereas our current system of nonstop devaluation encourages nothing but speculation.

But how would new money come into circulation, if banks are no longer allowed to create it through keystrokes on computer screens (and then lend out the previously non-existent money at interest)? Its simple, new money comes into circulation as it is mined, milled and minted. To anyone who tells you that private banks or central banks or ‘the Elite’ will benefit the most from the Gold Standard, this is why they are wrong. Yes, holders of gold would benefit from the initial changeover, from fiat to sound money, but after that it is a system that is more fair (nothing is perfect in this world) for everyone. An initial one time gain (of perhaps 300%) on the 10 ounces you hold might seem like a big deal, but the real change in the switch to sound money would come from banks losing the ability to create money, and the average person gaining that ability.

How would you feel if your retirement savings increased 66%, but your income decreased to almost zero? Probably mixed emotions! So now you know why private banks (and hence, their employees, analysts, researchers, etc.) will not be supporting a BiMetallic Standard without some, erghm, persuasion.

So how does new money come into circulation, again? The Federal Mint (of America, Canada, etc.) would be obliged to mint bullion into coins, free of charge (a small seignorage for operating costs was historically charged). You mine it, pay someone a nominal fee to mill it, you take the bullion to the mint, and you walk out with money. Notice a key difference, new money comes into existence, and no one is owed interest on that money!

Now there are lots of questions, lots of choices, how to go about something like adopting a BiMetallic Standard. A common one is, where will loans come from, if banks can no longer lend out more money than they have in reserves? Easy, loans will come from savings. If the bank has made $10,000 on ATM fees it can lend out $10,000. Not $100,000, $10,000. If you have some freshly minted coins, or some saved up, you could lend money. Simple interest would replace compound interest, ideally, as well.

Remember to check back with the Capital Research Institute, as we continue to unravel The Web of International Finance! Thanks for your time.

Posted in General, Gold Standard, Inflation | Tagged , , , , , , , , , , , , | Leave a comment

The Debt End Game

Posted on September 6, 2011 by Henrik

financial deadend2 The Debt End Game

Let us review some of the topics the Capital Research Institute (CRI) has discussed during the last few months and how they have come to fruition since then. In July, in our post “Creative Destruction – A New Economic Order” we mentioned that we believe that the US is on the same path as Japan, which resulted in the “Lost Decades” during which zero interest rate policies (ZIRP) where used to try to keep the bubble from busting, leading to insolvent zombie banks and corporations. The Fed announced on Aug 10, 2011 that interest rates are to be kept at close to zero until 2013, which illustrates our point that the US is on a similar path as Japan has been for the past decade.

We also mentioned in July in “The Financial System – A House of Cards” that the US was likely going to enter a recession in 2012. That was one week before the abyssal US GDP report that sent the markets tumbling. According to a recently released study by Merrill Lynch that used modeling done by Bank of America predicts that the chance of a US recession is as high as 80%. With the Philly Fed Index at its lowest level since March 2009 and consumer confidence at its lowest since May 1980, a recession is very likely. It’s fairly simple, without jobs people don’t have money to consume, without consumption and home purchases the US economy cannot grow.

This is the perfect storm in order for the Fed to implement further stimulus, since we believe it is unlikely that the Fed will lower the interest rate paid on excess reserves stored with the Fed, which amount to $1.6 trillion. If the Fed would reduce the rate to zero banks would have no incentive to store the reserves with the Fed and would be forced to choose higher risk loans to individuals and businesses, which could lead to out of control inflation. Another method of easing is called Operation Twist which was used in the 1960’s to lower the long term rates on US debt by selling short term treasuries and buying long term treasuries, therefore removing short-term liquidity from the system and driving down long-term rates. Such a strategy would help reduce costs for the US to refinance long-term treasuries with foreign central banks and reduce the amount of debt that would need to be monetized.

As we have been stating since April, further stimulus is in the cards, just what they will name it is the question. Unless some real budgets cuts are made and the deficit substantially reduced, things will only get worse rather than better, which holds true for the US as well as Europe. The great debt experiment is coming to an end, but the debt crisis is here to stay for many years. We need to start designing a financial system that works, fiat currencies and money based on debt might have been nice ideas back then, but it is time to go back to sound money under a gold standard. With a gold standard banks are not able to create money out of thin air and lending should come from private savings.

Since we started discussing “The End of US dollar Dominance” in January, the US dollar has lost value relative to all major currencies and will continue the decline due to the Fed’s attempt to print the debt away by devaluing the US dollar. China is tied to the US economy, even though they do not want to buy US treasuries, they have to in order to keep inflation manageable by reinvesting their account surpluses, but also in order to keep feeding the US more debt for Americans to purchase cheap Chinese made goods and therefore maintain consumption that the economy is dependent on. This interdependent relationship between the US and China is a real problem, since they are damned if they do and damned if they don’t.

Europe is in similar trouble, about 80% of Germans are against further bailouts and the German President Christian Wulff is accusing the European Central Banks (ECB) of violating its mandate with the mass purchase of European bonds stating: “I regard the huge buy-up of bonds of individual states by the ECB as legally and politically questionable. Article 123 of the Treaty on the EU’s workings prohibits the ECB from directly purchasing debt instruments, in order to safeguard the central bank’s independence,”. He further warned that Germany is reaching bailout exhaustion since Germany’s public debt has reached 83% of GDP and asked who will “rescue the rescuers?”…“we Germans mustn’t allow an inflated sense of the strength of the rescuers to take hold.”

The Bundesbank also slammed the ECB this month stating that bailouts violate EU Treaties and lack “democratic legitimacy”. Nobel laureate Joseph Stiglitz said at a forum of half the world’s Economic Nobel laureates that the Euro will likely fall apart unless Germany is willing to form a fiscal union with the rest of Europe since additional austerity in Greece and Spain is not the answer. He further stated that Argentina’s 8% annual growth rate after breaking its tie with the US dollar illustrates that “there is life after default, and life after breaking out of an exchange rate system”. Germany will lose a lot of money one way or another, either through bailouts or by sovereign debt defaults of the PIGS (Portugal, Italy, Greece, Spain).

Germany is facing hard times; they could create a new Deutsche Mark (DM), but as soon as that happens a lot of money would flow into it from the Euro since the DM would be considered a safe haven similar to the Swiss franc. A strong DM would hurt German exports and be bad for the export driven German economy. Sticking with the Euro means further bailouts and no end in sight of how many trillions of Euro’s are needed to back the PIGS finances. Similar to the interdependency between the US and China unfolds the relationship that ties Germany to the EU.

The IMF stated this weekend that the global economy is facing a “threatening downward spiral” and calling for the US and EU to abandon austerity measures in favour of stimulus. The Italian treasury has to redeem $14.6 billion in debt this week alone and $62 billion by the end of September, the largest amount in any given month ever. Even though the ECB has been buying Italian treasuries to stabilize the long term rates, the question is where all the money is supposed to come from? The ECB can continue buying treasuries from the PIGS for several trillion Euros or someone could realize the insanity in such a proposition and realize that default is the only right choice. Short term chaos is the price to pay, as long as we can implement a financial system that is not based on debt, it is worth the price.

Thank you for your time, please check back with the Capital Research Institute soon as we bring you further analysis of the current sovereign debt and currency crisis. It is time for a sound international monetary system, the longer it takes for everyone to wake-up to the facts and address the system, which is the real problem; all we are doing is kicking the can down the road again and pay the price later.

Posted in Economy | Tagged , , , , , , , , , , , , | Leave a comment