Sailing Through a Global Storm Without Enough Hot Air

The Great Recession

As noted in my last article, “Fed Loses Control of its Benchmark Interest,” bank liquidity strains are written all over this month’s troubles. Some may find that hard to believe because there is so much hot air (fiat money) still floating the system from a historical standpoint. There is a sound fundamental reason, however, that a lot is not enough. The diminished money supply is simply not enough to keep the world’s huge asset bubbles (hot-air balloons) moving around. Simply put: if you move or convert a LOT of big assets, you need a LOT of liquidity in banks to handle those transactions. 

The Fed originally pumped up money supply in order to intentionally create these asset bubbles. They, of course, denied they were “asset bubbles” by calling them a “wealth effect,” wherein the Fed stated its intention was to pump up stock and bond markets so the wealth created in those markets, especially stocks, would trickle down to the rest of the economy. However, the new money didn’t trickle. It just recycled in those assets, bidding their values up even higher. As a result the Fed blew up huge asset bubbles — bubbles in that they were unsupported by economic reality and were just puffed up by free money looking for places to go. It didn’t create new products or new factories; it just went around in not-so virtuous circles.

So, tell me this: how can the Fed ever have reasonably expected it could suck the hot air out of those inflated markets and not deflate the bubbles? The Fed believed it could release the hot air (massive quantities of money created out of thin air) without deflating the hot-air balloons it created. I’ve always thought the idea that they could reverse their magic without reversing its effect was plainly illogical — so blatantly illogical that I could hardly believe they thought it was possible, let alone that the whole world would go along with them on that.

They stated as being their endgame clear back when Bernanke was chair. Their hubris or naiveté in believing they could pull that trick off before the watching world, caused me to say for years they had no endgame. Their recovery program was unsustainable because it would implode when they started reversing the magic. You cannot lift the entire economy with hot-air balloons and then think you can suck the hot air out and that the economy will somehow magically keep floating. It’s absurd!

Thus, what I think we are seeing happen right now is that the size and quantity of those assets exceeds the money supply that once blew them up. When more of those assets (a lot more) were moved (or converted to actual dollars) this month than usual, the banks were unable to move (or convert them) because there isn’t enough in reserves to back up the bubbles if too much moves from bubble to bubble at once. (That would be a larger-scale version of the problem you have when a bank doesn’t have enough reserves to back its loans or deposits if too much money moves at once.)

Read the rest here: The Great Recession

Start the Conversation

Your email address will not be published. Required fields are marked *