US central bank: Alchemist or fake? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 16 April 2014
US central bank: Alchemist or fake? A  A  A

Salta, Argentina

It looks like the stock market is in the process of topping out. But if you'd bet heavily on a downturn, each time we saw one coming, you'd be broke by now. We wait to see what happens...

Meanwhile, we are still puzzling over the miracle produced by the Fed.

Yuri Geller could bend spoons. But the Fed bends the entire economy. Hardly a single price is unaffected. Hardly a single business plan or investment strategy goes forward without an eye on the central bank.

Jesus turned water into wine and multiplied loaves and fishes. But the Fed make the Nazarean seem like a two-bit shell game hustler. The loaves and fishes couldn't have had a market value of more than a few thousand shekels. Compare that to the Fed. It created $33 trillion worth of goods and services - out of nothing. Yes, dear reader, that is the total of purchases made over the last 30 years... on excess credit. We say "excess" because it is above and beyond the level of credit that had existed - relative to GDP - for many decades before. Roughly, from 1900 to 1970, the US had $1.50 for every dollar of output. Now, there is about $3.50 per dollar of GDP. The difference, over the last 30 years, is about $33 trillion.

Where did all that bounty come from? That is the question. Can something really come from nothing? Nihilo ex nihil fit. And yet...$33 trillion worth of 'stuff' seemed to have come from out of nowhere.

It didn't come from savings. The savings rate went down during this entire period. It didn't come from earnings either. Wages and earnings - in real terms - barely rose from the 1970's. How about from an increase in productivity or output? Nope. As we have seen, compared to output, this 'wealth' grew much faster.

That leaves only one possible source.

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You may think that banks lend out savings. Unun. They lend money that doesn't exist. Money comes into being when the loan is made. Banks no longer even have to maintain any significant reserves against non-payment. The whole system is one created by and presided over by the Fed...itself owned by the banks themselves.

As we put it last week, the Fed's theory - that it can build real wealth by increasing credit faster than GDP, forever - is 'childishly naive.' An old friend, Pierre Lemieux, wrote with a comment:

    The production of things is not done with money, but with real resources. If I see a car, I know it has been produced with steel, aluminum, plastic, labor, etc. That's the real side of the economy. We get on the financial side when we ask how this production was financed, that is, how people were motivated to release control of real resources. In most cases, they are motivated in doing so by receiving in exchange claims to other resources or consumer goods. Finance is the domain of the exchange of claims to real resources.

    The question, then, is in which circumstances does money (a very liquid claim on real resources) will help production (by reducing transaction costs), hinder it or, as you point out, create gainers and losers.

In a better world, credit depends on savings...which represent real resources. This naturally restrains credit growth, because there are only so many real resources and only so much savings representing them.

But in the world created by the Fed in the '60s and '70s, the new credit had no savings behind it. It was just "paper...just notations in the banking system...with no effective limit on the quantity of credit available. That is how this $33 trillion came to exist. It pretended to be real savings...representing real resources...which were then put to work to make the autos and houses that people wanted, but couldn't really afford.

In other words, the system created new claims on resources...which drew resources into the real economy. Neither past earnings (savings), nor current earnings (output) supported this economic expansion. Instead, it was all a claim on future earnings.

This is all a way of saying the obvious. If future output cannot keep up with this $33 trillion of excess credit, the credits themselves must go bad. That is, of course, the problem. The economy limps along...even with $1 trillion of extra QE money per year. It depends on more credit and more debt just to stay in the same place. Every year, more resources must be drawn from the future and enjoyed in the present. Every year, the claims on future earnings increase... and every year the debt becomes even more unsupportable.

Somehow... Someday... Those claims on the future will be marked down.

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

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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