First some figures.
This morning Bloomberg reported that the total amount of assistance provided by the US Federal Government has reached more than $7.4 Tn., or half the value of everything produced in the United States last year, to rescue the financial system since the credit markets seized up in the late summer of 2007.
According to data compiled by the Bloomberg news organisation, the unprecedented pledge of funds includes $2.8 Tn. already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, This financial commitment dwarfs the only plan approved by lawmakers, the Treasury Departmentâ€™s $700 Bn. Troubled Asset Relief Program. So far the Treasury has committed some $300 Bn. under the TARP,Â Â and has indicated that it would hold off until the new Administration is sworn in. Recall that the TARP was sold a a panacea for the nationâ€™s financial ills back in September. You know our views on this topic.
Last week Morgan Stanley reported that global losses from the sell-off of equities has now reached more than $30 trillion â€“ or more than twice the size of US GDP. This number only encompasses losses on traded equities and does not include other various write-downs, write-offs and value adjustments. For example the estimated hit to value of the US housing stock adds another $5.0 Tn. to the blood running in the streets.
Despite the toll to date, financial and economic conditions continue to deteriorate further. The World Trade Organization warned last Wednesday that the financing of global commerce is â€œdeterioratingâ€ amid the financial crisis and the situation is likely to worsen over the coming months. â€œThe market for trade finance has severely deteriorated over the last six months, and particularly since September,â€ WTO Director-General Pascal Lamy told ambassadors of the organisationâ€™s 153 members following a meeting with trade experts and bankers. â€œThe view expressed this morning by the trade finance practitioners is that the situation is likely to deteriorate further in the months to come,â€ Lamy said.
Citibank, one of the behemoths on our â€œZombieâ€ watch-list, has predictably gone to ground after months of denial, and over this past weekend, agreed to a Government bailout.
The Fedâ€™s balance sheet in the last year has ballooned from $ 1.0 Tn. to $2.4 Tn. reflecting the huge and largely unmonitored expansion of its lending activities that has been overseen by Fed Chairman Bernanke.Whilst this has stopped some banks from going to ground (temporarily) it has done nothing to remediate the underlying credit prblems or to forestall a significant slowdown in the real economy.
Various commentators predict that the magnitude of the downdraft and its severity will be unprecedented. Roubeni, for example, expects that US real GDP may have to fall by as much as 10% peak to trough (or by over a trillion dollars) before this is over. Note that in the worst U.S. recession since WWII, in 1957-58, the cumulative fall in GDP was only 3.7%. In addition, the cumulative fall in GDP in the 2001 recession was only 0.4% — and in the 1990-91 recession only 1.3%. On this view, the current recession may end up being three times as long and be at least five times as severe than the last two.
Through all of this the market for Treasury securities has held up remarkably well, even in the face of what is by now obvious to all as the greatest and most rapid expansion of Government finance in history. The reason for this is that at the present time the markets greatest fear is of deflation. However it is important not to ignore that Chairman Bernanke has in fact presided over the most rapid expansion of high powered money in the history of the Fed. The scale of the Fedâ€™s interventions are as unprecedented as they are impenetrable to the general public and to Congress.
Nonetheless questions are starting to be asked. For example, Bernanke responded with some derision last week when questioned on the stability of the Fedâ€™s lending programs. “We have never lost a cent.” he stated in response to questioning on the Fedâ€™s discount window operations, “because we haircut the collateral.” To which we respond, “â€¦but this is collateral that the market itself does not want to accept, what makes you so sure you know the values?” One outcome of these massive operations so far has been that the Fedâ€™s ability to control short term rates has been compromised. Due to the various distortions caused by the expansion of their balance sheet they no longer can perform a fundamental task with the same degree of precision and predictability as in the past.time.
For the time being however, the rapid increase in high powered money has not translated into higher consumer prices. This is due to a massive fall in monetary velocity. When velocity picks up, as it always does, it will very difficult for the Fed to sterilize these injections. Moreover, our opinion is that that the market has not fully discounted the effect of new Treasury supply on Treasury prices. There are massive built-in deficits that must be financed for years to come.Thus in addition to the devastation already wreaked on investor portfolios as described earlier, we believe that there will be a massive sell-off in Treasuries in response to actual and perceived accelerating inflation due to excessive dollar creation and new Treasury supply.
Hereâ€™s the Report Card: The US has a central bank that has blown its balance sheet on toxic waste, lost control over some of its monetary levers, and has presided over a massive unsterilized increase in high powered money. Meanwhile there is a swingeing recession on the horizon which will be accompanied by an already significant loss of financing flexibility and a likely flame-out in fixed income markets at a most inopportune time.
Expect the inevitable blow-off to begin in the next 6 to 18 months. However, the economic, social and geo-political implications of this ruinous escapade will likely take decades to play out.Thus unfortunately, not only for the good Professor, but for us all, this period in World Financial history will likely one day become known as “Bernankeâ€™s Blunder”. Knives are already being sharpened in Washington.
The Bottom Line: It is unlikely that the current Fed Chair will last out his first term.
“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.”
Thomas Jefferson 1802