Last week, we presented an equity "valuation" analysis based on Austrian economics, which concluded that the only thing that matters for the economy and for asset prices in general, is the amount of credit money moving one way or another at the margin, ie how active global central banker printers are. Unfortunately, in this economy of record correlations, and in which alpha creation is now impossible, this may well be the only approach to capital markets that works any more. Today, Tradition Analytics takes this analysis from the micro the macro level, explaining why the US, and global, economy is now like a shark - cash has to move (inward) or else the economy will suffocate. Naturally, nothing could make Bernanke happy- according to Tradition, "To sustain the up-cycle banks will have to pump out net new credit probably in the order of about $1 trillion in the coming 8-10 months, even larger than the $700 billion pumped out in the previous 8-10 months." Alas there is a problem with this, very much along the lines of what we discussed last week, which is that the new crude baseline is now a triple digit number, not one in the $30s or even $60s: "it is going to be difficult to sustain this level of credit expansion, not only due to the sheer gravity of the inflation problem that would follow, but also simply due to the fact that it is always increasingly difficult to extend more credit at the margin, and this time into an economy that is already steeped in credit."
Complicating matters is the long-discussed contraction of the business cycle, as volatility swings get ever wilder and with a greater amplitude, courtesy of record central planning encroachment which swings the global economy from one extreme to another with reckless abandon. To Tradition "it would suggest that cycles are getting progressively shorter in the great debt era and this in turn means the potential loss of monetary control, policy overreaction and misdirection, macroeconomic value destruction over time, and the risk of very deep, acute financial and banking crisis." In other words: the Fed is now boxed in a corner (and has been for years, maybe decades, in fact since its inception in 1913), and anything it does will push the pendulum to either one or another extreme. In this light, what consumer confidence does today (whereby consumers are confident because they are confident) is beyond ridiculous.
The bottom line from Tradition:
- The US economy, using growth in M2 money supply as a cyclical measure, has now been in a boom phase since the start of 2010. This 2-year boom is coming to an end. Credit and money growth has been running at such breakneck speeds that in order for the banking system to sustain the boom it would need to pump out roughly $1 trillion dollars’ worth of loans in the coming 8-10 months.
- If that were to happen, inflation will quickly become the most import problem for the US economy and the boom would be extended to such a degree as to make not only the inflation threat enormous but the crash risk even bigger at a later date.
- However it is going to be difficult to sustain this level of credit expansion, not only due to the sheer gravity of the inflation problem that would follow, but also simply due to the fact that it is always increasingly difficult to extend more credit at the margin, and this time into an economy that is already steeped in credit.
- The resulting bust could be sharp as 2012 unfolds. By the middle of the year we expect that the slowdown in credit expansion will have forced the productive sector into another liquidative bust phase. Employment numbers will begin deteriorating and production data will likely suffer again.
- If we are correct in this outlook then the current US boom phase may last little past 2-2½ years. This means that since 1991 the three US boom cycles have roughly halved in length from 10 years (1991-2001), to 5 years (2003-2008), and 2-2 ½ years (2010-2012). The implication of this should not be underestimated. It would suggest that cycles are getting progressively shorter in the great debt era and this in turn means the potential loss of monetary control, policy overreaction and misdirection, macroeconomic value destruction over time, and the risk of very deep, acute financial and banking crisis.
And another useful observation, looking at the credit impule, only this time from the perspective of credit money:
We must caution that, as with every business cycle, the boom immediately sets in motion the seeds of its own destruction. Credit pumped into the system needs to grow at an accelerating pace or else the production structure will start to adjust once more toward a more consumer oriented one and non-specific factor resources will be bid away from higher order processes quite quickly, causing many of those industrial projects to fail before even reaching completion. In fact it is perhaps not surprising to note that in the most recent month of data producer prices actually fell and have exhibited no upside in h2 2011.
We should also note that such a rapid increase in inflationary credit is historically very difficult to sustain. Below we have adjusted our preferred US money supply measure, M2, into a normalised scale of its 4-month moving average annualised change (smoothed).
It is clear to see that since 1959 (available data) the measure does not typically move more than 2-standard deviations from the mean and when it does these episodes are very short-lived. Remember: with inflationary credit cycles the pace of new credit needs to be increased (i.e. 1st derivative of money supply growth must be greater than zero) for the boom to be sustained. In other words when the graph above is trending lower the bust is being set in motion.
We fail to see what the problem is: the central planning tyrants have always thought they know what is best for everyone, and how to make everyone's life good, at least in their view, if in the process they just happen to make the lives of the uber-wealthy that much better. And at the end of the day, nothing has crashed yet