By Charles Hugh Smith: An unprecedented tsunami of state-borrowed and Fed-printed money has failed to fix the systemic crisis.
Borrowing and printing $10 trillion hasn't fixed anything; it has only
raised the reservoir of risk to the top of the dam. Cracks are opening
as the pressure builds, and we should not be surprised when risk and
consequence reconnect and the dam gives way.
What happens when all systemic risk ends up concentrated in the central state? Let's
start by noting that the central state (Federal government) backstops
every category of risk: major flooding, crop failure, bank failure,
student loans, old-age pensions, healthcare for the elderly and
low-income, disability, and so on.
The Federal government pays for all these programs by collecting taxes
and borrowing the difference between tax receipts and expenditures by
selling Treasury bonds.
The foundational faith of this concentration of risk in the state is
that crises that require massive deficit spending--borrowing vast sums
to "get us through a rough patch"-- will be intermittent and brief.
The Great Depression upended that faith: certain types of systemic financial crises were neither intermittent nor brief but chronic and resistant to conventional fixes.
The unprecedented borrowing and spending of World War II spawned a new faith: that
the only fix to chronic systemic financial crises was to borrow and
spend monumental amounts of money that in essence replaced all
private-sector demand lost in the crisis and then some. This "fixed" the
chronic crisis by flooding the real economy with enough money that
households and businesses could pay down or liquidate old debt (i.e.
deleverage) and earn enough to save money that accumulated the capital
to fuel a new round of credit expansion.
In terms of risk and moral hazard, all systemic risk was offloaded onto
the state, and the consequences of poor risk/money-management decisions
were obliterated by the tsunami of borrowed Federal money.
In the quasi-religion of Big Government Borrowing as the risk-free
fix to all crises, those saved by Big Government borrowing/spending are
victims: victims of unpredictable Nature (drought, illness) or financial crises beyond individual's control (bank failures).
But this worldview excludes moral hazard, that is, the causal connection
between poor choices/high risks and poor outcomes. Once the state
backstops every loss, regardless of origin, it not only backstops
innocent victims, it also backstops non-victims, those who made poor
choices that resulted in losses and the parasitic criminal class of
those gaming the unlimited backstops of the state.
This dominance of moral hazard discourages integrity and
responsibility and incentivizes risky speculation and irresponsible
choices and lifestyles. My Mom (83) has told me that she's heard men
of her generation exclaim that there is no need to modify their
unhealthy lifestyle because "the government will pay for another
bypass."
I cite this as an example to show that moral hazard in a system where
the state backstops every risk is not reserved for financiers; it
infects every recipient of state backstops.
If the state offers someone a near-zero-down payment mortgage at a low
interest rate (for example, an FHA or VA mortgage), this is the
equivalent of offering a gambler in a casino a compelling deal: keep any
winnings (if the house rises in value) and the state absorbs any losses
that result from the house declining in value (defaults, etc.)
As noted in the series' first two parts, The Source of Systemic Crisis: Risk and Moral Hazard (August 21, 2013) and The Grand Experiment: Offloading Risk onto the State (August
22, 2013), the potential losses from open-ended risk are also
open-ended, while the state's ability to borrow money to backstop every
loss is intrinsically limited.
In other words, the Big Government Backstops Everything faith is that
crises and losses will be intermittent and shallow, and thus well within
the government's ability to unleash a cleansing tsunami of borrowed
money that will flood the economy with enough cash and credit to wash
out any and all losses.
Systemic financial crises can be fixed with More of the Same--just
unleash an even larger tsunami of free (borrowed) money to wash away the
losses and financial ills.
The problem with this faith is that the open-ended concentration of
risk in the state creates open-ended demands for backstops that
eventually exceed the state's ability to borrow money. It's
absolutely critical to grasp the difference between government borrowing
in World War II and government borrowing in the present.
In World War II, the state imposed wage/price controls and forced full
employment by the military draft (here's 15.5 million jobs and you're
going to take one) and an extraordinary expansion of industrial
production of weaponry and war materiel.
This created a vast pool of private savings that could be invested in
War Bonds, the Treasury bonds sold to fund the war. This accumulated
savings also provided the capital foundation for the postwar expansion
of credit and consumer spending.
The present borrowing and spending tsunami is fundamentally different: rather
than rely on private savings being invested in Treasury bonds (debt),
the central bank (Federal Reserve) creates trillions of dollars which it
uses to buy Treasury bonds and home mortgages:
$2.6 trillion created and counting:
Meanwhile, Federal debt has exploded as borrowing a tsunami of money has
turned from "getting through a rough patch" to chronic massive deficit
spending:
Note the structural gap between Federal receipts and spending:
Another critical difference between the World War II tsunami of state
money and the present is that the money created by the Fed isn't going
into the real economy, it's feeding speculative asset bubbles. Note the near-perfect correlation of the S&P 500 stock market index and the Fed's balance sheet/creation of money:
In other words, the state/central bank backstopping of systemic risk
now focuses on creating phantom wealth via speculative bubbles rather
than forcing full employment. Rather than "draft" 15 million
unemployed into a low-paying civilian equivalent of the World War II
military machine, the state/central bank has endeavored to inflate asset
bubbles that are supposed to create a "wealth effect" that will
magically persuade households and enterprises to go out and borrow and
spend.
What are the consequences of a central bank creating trillions of
dollars for speculation and a central state borrowing trillions of
dollars on a permanent basis?As noted before, risk cannot be extinguished, it can only be offloaded onto someone else or masked for a short time.
The consequences of this sleight-of-hand (the Fed creates money to buy
Federal bonds so the government can borrow and blow trillions of
dollars) are not yet visible, but there will be consequences at some
point; the risks have only been temporarily cloaked.
Federal debt has risen $7.1 trillion since the current systemic
financial crisis began in August, 2008, from $9.6 trillion to $16.7
trillion. (You can see for yourself on Treasury Direct).
That is an astonishingly large increase. Add in the nearly $3 trillion
created and injected into the financial sector by the Fed and the total
money-tsunami unleashed to "fix" this systemic financial crisis is close
to $10 trillion.
This unprecedented tsunami of money has failed to fix the crisis.
Instead, it has created a vast and as-yet invisible risk of collapse of
the state/central bank system itself. By concentrating systemic risk
into the state, we have not extinguished risk; we have only pooled it
into a reservoir dammed by one barrier: the state's ability to borrow
and spend virtually unlimited amounts of money.
As I have described in Why Isn't There a Demonstrably Correct Economic Theory? (August
16, 2013), creating money and credit simply creates more claims on
existing real-world resources--it doesn't create new wealth or
resources. When those claims vastly exceed the underlying
wealth/resources, the system of credit and currency claims will implode.
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