Ad Blues

The Fed has a huge bias in favor of errors that benefit powerful, moneyed groups... leading us to guess that its next error will be, once again, to under-price credit for privileged borrowers.

Monday, August 12, 2024 

Bill Bonner, writing today from Poitou, France

Тhey [Romans] were forced to debase the currency. Debasing the currency for them was the same as borrowing is for us. It basically shifts the cost of solving your problems on to the future. Now, you can do that if the future doesn’t have any problems of its own. And we know that never happens, right? So the future has to deal with its own problems plus the cost of the past problems that you’ve deferred the cost of.  

—Joseph Tainter  

After our car blew up, we rented a Citroen van. All was well until a light flashed on, telling us to put in something called ‘AdBlue.’ It further informed us that if we didn't do so within thirty kilometers, the car would not start. 

Oh my... another thing to deal with. 

Adblue? A French website told us that it is an “additive required by Europe intended to reduce harmful emissions from diesel engines. The additive goes into the exhaust system and converts toxic gas into water vapor.” 

Jeepers creepers. We were out in the country. Where could we get this ‘AdBlue?’ We hunted on the internet and found it at a filling station not too far away. But the exercise took time and attention away from other things. 

“Tainter was right,” we said to Elizabeth. 

“Tainter who?” 

“Joseph Tainter. He explained why societies always go into decline. Each challenge brings a response. And each response takes energy. Rules and regulations are put in place... but rarely removed. So, people end up using energy for things that no longer matter. And rather than pay the full costs of the response, they borrow or print the money... so as to push the costs onto the future. Then, as the future happens, it is burdened by debts, rules, laws, and regulations that are relics of previous problem solving.”  

Central Financial Planning

Last week, we saw that every Fed policy choice is an error. There are an infinite number of possibilities for the Fed Funds rate. Choosing just the right one at just the right time is very unlikely. The Fed is trying to do something that never works — central financial planning.  

Each and every choice made by the Fed is an error; it cannot help but misprice credit. A rate that is too high prevents borrowers from getting the credit they need. A rate that is too low encourages them to borrow too much. Either way, the economy is distorted and enfeebled. 

Each policy decision is an attempt to deal with a current problem. But the error causes problems downstream that then must be addressed with more policy choices, causing even more problems. The decade-plus of ‘zero’ interest rates, for example, 2009-2021, led to today’s inflation and $35 trillion in debt. So, the Fed is now trapped between ‘inflate or die’ — fighting inflation while also trying to prevent a debt meltdown. 

We also saw that the Fed’s errors were not random. If they were sometimes too high and sometimes too low, they would average out to somewhere close to where they ought to be. Instead, the Fed chooses rates that are almost always too low, thus encouraging too much credit and setting the country up for a credit crisis. 

In 1968, economists advising the Johnson administration thought they saw a problem. The nation needed more credit. It would be a simple and painless move, they believed, to cut the domestic dollar off from gold. Problem... solution! Since then, the amount of credit outstanding in the US has gone from $1.4 trillion to $94.5 trillion today. That’s a 66-times increase. US GDP, meanwhile, was around $1 trillion in 1968. Now, it’s $28 trillion. (We may have previously gotten these numbers wrong...) 

In other words, credit has expanded three times faster than output. Corporate debt too has risen thirty-five times since the dollar became a ‘credit money.’ The cheap credit was what made possible the ‘financialization’ of the US economy — with much higher levels of capitalization, deal flow, debt and M&A activity.  

So, imagine your family. In 1968, you owed $100,000. Now you owe $6.7 million. Imagine the good times you could have had — spending that extra $6.6 million that you never earned. Houses... cars... vacations... granite countertops... air-conditioned garages and in-ground pools — they may have exceeded your earnings... but not your credit.  

You can imagine too how the local economy would have gotten a boost. Typically, people spend money from wages. So, in order to go into the local economy... money must first come out of the local economy. But this was not a real money boom, this was a credit money faux-boom. It is as if the money came like manna from Heaven... it gave your family and the whole community around you a big ‘stimulus.’ 

Making it Worse

But wait. Say your own income rose in step with GDP. You earned $10,000 in 1968. Now, you earn $280,000. Not to put too fine a point on it, but you are broke, busted... no bread... nuthin.’ You wouldn’t be able to keep up with the debt service, even if you devoted 100% of your pre-tax earnings (at 5% interest). 

But instead of recognizing the problem and correcting it, US authorities are making it worse... by pushing even more of today’s problems into the future (with $2 trillion annual deficits) and preparing to cut interest rates, (thereby making it easier to borrow more money). 

Problems are sometimes real and important.  And sometimes phony and convenient. AdBlue? We don’t know. 

But the Fed has a huge bias in favor of errors that benefit powerful, moneyed groups... leading us to guess that its next error will be, once again, to under-price credit for privileged borrowers. This will help solve the problems of recession/job slowdown/bear market on Wall Street/funding federal deficits... and so forth. It will also give rise to even bigger debt and inflation problems in the future.  Like the Romans, the feds will be ‘forced to debase the currency.’ 

Let us hope that the future has no problems of its own. 

Regards, 

Bill Bonner