How will the credit link break? - The Daily Reckoning

How will the credit link break?

Mar 17, 2015

- By Bill Bonner

Bill Bonner
The End of the Road, Argentina

Dear Diary,

Part II of our speech in Cafayate on Sunday:

Not content to wreck its bond market, Japan has taken a sledge hammer to its stock market too.

Here's the report from the Wall Street Journal:

    The Bank of Japan's aggressive purchasing of stock funds has helped Japanese shares climb to multiyear highs in recent months. But some within the central bank are growing uncomfortable about the fast-paced rally and the bank's own role in fueling it.

    Since Gov. Haruhiko Kuroda took office in March 2013 and introduced monetary easing of what he called a "different dimension,"...

    During the past two years, the central bank entered the stock market roughly once every three days, picking up a total of ¥2.8 trillion ($23 billion) of ETFs that track Japan's major stock indexes, according to Bank of Japan records. That distinguishes it from the U.S. Federal Reserve and European Central Bank, both of which have bought bonds to pump up the economy but haven't directly bought stocks.

How about that?

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I have always been happy with three dimensions. That was plenty.. But not for Haruhiko Kuroda. He's gone where no sane central banker ever dared to tread....into a fourth dimension!

And we'll see where that takes him.

But let's turn our attention to the US. As Yogi Berra would say, America is going to come to a fork in the road...and it's going to take it.

US central bankers aren't as aggressive as the Europeans or as innovative as the Japanese. What will they do when the US stock market sells off?

Prices are very high on Wall Street. By one measure, 97% of the time, historically, they've been lower. And now, profits are falling. Sales are slack. Growth is sluggish, with the US possibly entering a recession later this year. Besides, crashes and bear markets happen; this seems as good a time as any.

When the next crisis comes, the fork in the road will be a choice. The Fed can either admit that its policies have not worked, chuck them out, raise rates back to normal and let the market sort out the mess. Or, it can follow the Europeans and Japanese towards more aggressive intervention - including massive QE and direct stock buying.

I don't think there's any doubt about what it will do. It will go deeper into that heart of darkness.

In fact, I think central banks and central governments now have revealed the full madness of their intentions. Well, maybe not the full madness...they haven't thrown money from helicopters yet...but that will probably come.

So far...

-They will set interest rates at preposterously low levels for years and years.

-They will finance 100% of government deficits - forever, if it comes to that - with printing press money.

-They will also pump up the stock market with this same money-from-nowhere. One and a half percent of market capitalization is nothing. Soon it will be 5%...and then, why stop there?...10%...and 50%.

You'd have to be brain dead - or a modern economist - not to be staggered by the audacity...the ballsy mendacity...and the incredibly big lie that undergirds the whole thing - that you can create 'money' out of nothing and use it to pay for wars, schools, highways, salaries for bureaucrats...

...and also to acquire real businesses.

I recall Lenin's quote: the capitalists will sell us the rope we use to hang them. Now, the capitalists don't even sell the rope; they give it away, for nothing.

But what's not to like? Stocks holders are getting rich. Bondholders are making money. The government can spend as much as it likes. And the voters are bamboozled by it; they think it helps make the economy work better.

This is going to be a hard habit to break.

    So, here's the gist of my conclusion. Governments won't break the habit of getting something for nothing. It will break them.
But how? It looks like they've got the perfect hustle going. They create money. But consumer prices don't rise. Everybody's happy.

Obviously, that won't work forever. I don't care how many knobs you turn or how many levers you pull. It doesn't work that way. Ultimately, you're putting rusty nails and on the ground...and you're going to step on them. How? When? Nobody knows. But I'm going to take a guess...

And here I'm no long using my powers of observation to tell you what is going on...I'm using my intuition and guessing about what might come next.

The weakest link in the central bank chain, I believe, is credit.

So let's look at how this link might break.

When we say the central bank is 'creating' money, what it is actually creating is credit. Out of nowhere. And unlike even traditional paper money, this credit can vanish as quickly and easily as it got here in the first place.

You can't hoard it. You can't put it in your safe. You can't take a wheelbarrow full of it to the grocery story for a loaf of bread. Credit depends on trust. And when a financial system implodes - which is what always happens when there is too much debt - the machinery of borrowing and lending will seize up. No one will trust that he will get paid. Credit will simply disappear - trillions of dollars' worth of it - overnight.

This is, of course, not the end of the world. Nor even the beginning of the end. But it will be the end of the beginning of the money world, 1971-2015. Then, the end can begin...

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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