Coming Uncorked

On Tuesday something incredible happened.  The Dow closed above 15,000 for the first time ever.  What a joy to be alive and bear witness to the great miracle of our time.

Whereas just 100 years ago the new marvels were flying machines and bucolic indoor plumbing…these days we have iPads and Dow 15,000.  Without question, iPads are quite marvelous.  Without question, Dow 15,000 is quite grotesque.

Without question, extreme government price fixing of money has blurred the line between real economic growth and the illusion of economic growth.  Often times it’s difficult to tell the difference.  Yet sometimes the difference becomes crystal clear as misallocations of capital reach extremes…

Consider the dot com bubble of the late 1990s.  Or the housing bubble of the mid-2000s.  These first appeared to be reflections of real economic growth.  Later it became crystal clear they were illusions of economic growth…destructive miracles of monetary policy.

For several years, it has been fairly obvious, if not crystal clear, there’s a Treasury bond bubble.  No one quite knows just when it will blow.  But holding Treasuries right now is like holding a lit stick of dynamite…better to chuck it off sooner than risk losing a digit or more.

Banks are Starting to Lend Again

Similarly, Dow 15,000 has brought clarity to the latest stock market run up.  It all now makes sense.  Prior to 15,000 it wasn’t quite clear if the stock market’s rise was purely Fed induced or if it was supported by the early foundations of a new boom.

But with the notching of this milestone, it’s obvious this is becoming another one of the great boom bust cycles of our time.  What’s more, it could puff up much farther and longer than any honest soul of sound mind and clear conscience could possibly fathom.  We sincerely don’t like it.  But we are determined to enjoy it.

Clearly, much of the economy’s activity is based on a creaky foundation of debt, perpetuated by an endless supply of paper money.  However, at the moment, it is still not clear whether the economy’s strengthening or weakening.  Some economic indicators are rising.  Others are declining.

In the midst of all this confusion is the ominous word that, according to the latest Fed Senior Loan Officer survey, banks are starting to lend again.  If this is so, and we have no reason to believe it isn’t, life as we’ve known it since the 2008 financial crisis is about to change.  Here’s why…

The Fed has inflated their monetary base from $900 billion in late 2008 to $3.3 trillion today.  But as the money base tripled something remarkable happened; the money never made it into the economy.  Generally this is because of the extreme fear, increased lending standards, and the need for banks to repair their balance sheets following the housing market blow up.

Coming Uncorked

Because of these factors the transmission device for Bernanke’s funny money malfunctioned.  Rather than flooding into the economy, the new money sat on bank balance sheets or was used to buy Treasuries.  This effect, or lack thereof, in central banking parlance is called pushing on a string.

The central bank pushes on one end of the string by expanding the money supply and the other end of the string, which is represented by the money’s entry into the economy, doesn’t budge.  That’s why, even with all the money creation, price inflation hasn’t yet followed suit.

“During the second half of last year, the major U.S. banks finally completed the cycle of post-financial crisis balance sheet repair,” said Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, in a recent report for clients.  “Now they are focused on using their balance sheets.”

This means the transmission device is finally beginning to function again and credit is beginning to flow into the economy for the first time since mid-2008.  This also means inflation is about to come uncorked.

When banks start loaning out money to businesses in earnest, several previously hidden consequences of Bernanke’s easing money policies will quickly be revealed.  Considering the money multiplier effect and the “magic” of fractional reserve banking, at some point, each $1 trillion added to the Fed’s balance sheet could translate into $5 trillion – or more – of money flowing into the economy.

Unfortunately, this will inflate more than just stock prices.  It will inflate all prices…and Bernanke will have to reverse course and begin removing the easy money that’s been pumping up stocks.  When that happens, watch out below.

Sincerely,

MN Gordon
for Economic Prism

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