The Great Deleveraging
Big Picture has copied a post from John Mauldin titled "the Trend May Not Be Your Friend."
Something that I have said in the past is that I think the banks need the money that has been put into them just so you can go to your bank and get your money out. Without the money that has been put in I believe the system would have collapsed and the crap the media is feeding us is just media bites that sound good.
In John's piece I take out this quote:
It’s a bit misleading to talk about money supply, because what money really is is roughly $2 trillion of cash and then $50 trillion in credit. Because what do the banks do? They take deposits in and then they borrow money to leverage them up. I take my credit card and I spend with it. I borrow against a house. I have an asset that rises, and I borrow against it.
We have two trillion dollars of actual cash propping up $50 trillion in credit. If we all decided to settle and pay off everything, we couldn’t do it because there is not enough cash. There would be massive asset deflation. We, as a nation, are levered 25 to 1, or we were. Now, that $50 trillion is in a real sense the money supply because that is what we are all pretending is real money. I lend you money and you pretend you are going to pay me back. Then you pretend he [pointing at another attendee] is not going to call your debt for cash, and we are all going to keep the system going. Because if we all try to pay each other back at once, we are all collectively — and this is a technical economic term — screwed.
For the economy to be healthy and fundamentally strong leverage should probably not exceed about 1 to 10 and 1 to 8 is better. As near as I can tell the whole securitization process simply increases leverage without reserves and I am not sure that its leverage effect is calculated into this mess. It would be when looking at an individual financial institution that is holding some that they intend to sell, but once it is out there and not being held by an institution I don't see how the leverage effect gets measured. I tend to think the degree of leverage is understated.
So, leverage is declining and that reserve is simply being used up, for example, tons of loans have been called and the cash is being applied to the debt. The reserve that is there now is new care of the government and I think the only reason the financial system hasn't collapsed because there would be no cash to keep the system going otherwise.
I have also made comments in the past on the money supply in that it is so enormous for prices to actually catch up to what was there, well, we would have to see about 500% increases. The declines in the past year suggests to me that we still have "wealth" stored in various assets and if we all tried to trade them in for usable goods today or at the same time we'd see price increases in the 250% range.
If you double the reserves, you halve the leverage is one thing that is happening, so for current credit reserves need to triple, and that is without the hidden leverage. Also if the cash pays debt, then the calculation completely changes. If you took half the reserves and applied to debt, well, you'd have 24 leverage of half the amount, or you'd have leverage of 48 on the credit left. If it is all used you end up with undefined leverage, but say you replace 100%, well, now you've reduced the leverage to 23 from 25.
The pulling money out of credit and paying down debt really removes cash from the system and only marginally reduces leverage. I think this would be a simplification of the "velocity" of credit contraction versus money supply. This kind of thinking is what put me in the deflation camp about 2 years ago.
Other things that keep in the deflation camp is inablity to raise wages in an employer's market and homes still are not affordable relative to wages.
To now see an inflation will depend on monetary policy. If end up adjusted so leverage is in the range of 10 to 1 and then do not ensure that it is not abused again through monetary policy, well, you can get massive inflation.
But I doubt that some running of the printing press will cause inflation at all because the velocity of deleveraging is so much faster then the printing press and is destroying money supply.