The War on the Credit Cycle - Vivek Kaul's Diary
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The War on the Credit Cycle

Feb 2, 2016


RHINEBECK, New York - We spent the weekend up north...where people put 'Feel the Bern' bumper stickers on their Subarus.

In a tavern in Rhinebeck - where we are writing - the 'socialist' slap seems to have lost its sting. There is a reverential portrait of FDR near the bar.

'He's the only candidate who makes any sense to me,' said a local. 'You can't trust Hillary. And the Republicans are all nuts.'

He's right...

You can't trust Hillary. The Republicans may all be nuts. And socialism 'makes sense'... in a simpleton kind of way.

Most voters want more stuff. Sanders offers to take stuff from other people and give it to them. That 'makes sense', doesn't it?

Too bad. Because as Maggie Thatcher pointed out, you soon run out of other people's money.

But the voters of Dutchess County don't seem to be concerned.

Back to the markets...

Japan Drops the Big One

'Thank Goodness That's Over', proclaimed Barron's on Friday, as the Dow added nearly 400 points.

But is the bear market really over?

What sent the Dow soaring was a surprise rate cut - this time by the Bank of Japan. This left short-term rates in Japan at negative 0.1%.

As we covered in the December issue of our monthly publication, The Bill Bonner Letter, in addition to the War on Poverty, the War on Drugs, and the War on Terror, there's also a War on the Credit Cycle. It is a war to prevent a correction in the credit market. Credit has been increasing for the last 33 years - largely thanks to the feds' undying support.

Before the link between the dollar and gold was severed, credit was rationed by a market. When savings are abundant and borrowers are few, supply and demand dynamics caused the price of credit to fall.

This lowered the cost of capital, discouraged saving, and allowed businesses to undertake projects that, at higher interest rates, would not have been possible.

Thus stimulated, economic activity increased...businesses expanded...wages rose...spending increased...corporate profits, and the stock market, usually went up...and interest rates rose as more and more borrowers competed for fewer and fewer available savings.

Higher rates pinched off the credit expansion and encouraged people to save more money. Stocks, now competing with higher yields in the bond market and on bank deposits, went down again.

That is how the credit cycle is supposed to work. It naturally corrects - in both directions.

Smarter Than God

But then along came the post-1971 'fiat' dollar...

And with it came a credit system that no longer needed savings...central banks that were determined to hold down the cost of borrowing, no matter what...and PhD economists who believed they were smarter than God.

Since the big change in the money system, markets have been pushed into the background; the feds now decide how much you pay for credit.

Twice this century, markets have fought back. And twice, the Fed has beaten them with a fire hose of rate cuts, bailouts, and bond buying.

Last week, we showed you an important chart from Deutsche Bank. It revealed how closely gains in the S&P 500 had tracked the ballooning of the Fed's balance sheet since the start of QE in late 2008.

Naturally, investors have gotten used to the idea that central banks have got their backs. So when the Bank of Japan announced it was dropping short-term interest rates into negative territory for the first time ever, investors got the message.

On Friday, the U.S. stock market put in a strong rally. The Dow ended the day up 396 points - or about 2.5%.

Plenty More 'Ammo'

We've been getting a lot of feedback on our note about Sarah Palin's use of language. Our favourite was this from a dear reader:

'Having fun' in writing about Sarah Palin? Then you have a lot in common with my ex-husband on what you think is fun. I am not sure I like you much better than him, either...

Completely understandable...and to the point.

We feel we must alert new readers: Here at the Diary, we are not always so clear...or so direct.

When we were younger, we had answers - clear, quick, and confident. Now, all we have is questions. And we're not even sure which ones to ask.

Is Sarah Palin really the dumbbell she appears to be?

We don't know the answer. More than one wily scoundrel has been elected to office by pretending to be a 'man of the people'.

Does Bernie Sanders have any economic ideas that haven't been proven idiotic?

Is the bear market on Wall Street over?

Darned if we know that either...

But we are pretty sure that the feds' War on the Credit Cycle is not over. In fact, it has barely begun.

This is a war that the feds can't afford to lose. The Deep State - the 'shadow government' that really rules the US - depends on more and more credit to keep expanding its power and drawing wealth away from the public.

Yes, the Fed famously 'used up all its ammunition' in driving rates to zero. But it has plenty more weapons such as negative interest rates...'helicopter money'...and banning cash from circulation to prevent us from stuffing it under the mattresses.

Not only can the concept behind this predictive tool predict the next terrorist attack, but it may also predict the next big move in financial markets.

And the Deep State has plenty of allies.

So far this year, the president of the European Central Bank, Mario 'Whatever It Takes' Draghi, announced that there would be 'no limits' to how far he would go in his fight against the credit cycle.

Draghi has already pushed short-term rates in the euro zone into negative territory. It joined Switzerland, Denmark, and Sweden in the world of 'NIRP' (negative-interest-rate policy).

Now, the Japanese have followed suit.

More war ahead...

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

Disclaimer: 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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