This Credit Event Could Crush the Stock Market

By Bill Bonner, Chairman, Bonner & Partners on January 16, 2014

Now our nerves are settled. We can sleep at night. There’s nothing more to worry about. Christine Lagarde, head of the IMF, has reassured us.

Madame Lagarde tells us that further scaling back of QE won’t mean a thing, as long as the Fed goes about its tapering in a gradual, measured way, which of course it will.

“We don’t anticipate massive, heavy and serious consequences,” she said.

But wait…

She must be wrong about that. If the Fed were to continue to cut back its bond-buying, the stock market and the economy would go into withdrawal shock. The economy would wobble. Stocks would fall. And Janet Yellen would promptly go into a huddle with other Fed governors and come out with an announcement: more QE!

A New Depression?

We don’t know whether Madame Lagarde is aware of it or not. Fed economists must be. They must know that the only thing keeping the economy from slipping into recession is the Fed’s EZ credit.

The following figures were shown to us by economist and author of The New Depression: The Breakdown of the Paper Money Economy, Richard Duncan. He spelled it out for us…

Since the 1980s, we have had an economy that grows on credit. In 1964, the global economy owed only $1 trillion. By 2007, total global credit had expanded to $50 trillion. The global economy depends on it.

But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one.

When credit growth slows, so does the economy.

How much credit growth does it take to keep the economy chugging ahead? Duncan says it needs an increase of at least 2% after inflation, or the economy goes backward. Every time credit growth has fallen below 2%, he says, we have had a recession. No exceptions.

A growing, expanding economy naturally leads to more credit. Households borrow for new homes and appliances. Businesses borrow for new plants and machinery. Investors borrow to finance startups and speculations. Government borrows, too, to cover deficits. And all this borrowing is what leads to new demand, new jobs and new output.

But instead of stimulating a real, healthy recovery, the Fed has only been able to simulate one. The real economy limps along. Real per capita disposable income has risen just 0.7% a year over the last five years. The personal savings rate is only 4%. (It was 10% in the 1980s.) And although the consumer deleveraging cycle is over (for now) much of the new credit creation is once again in the subprime category. (Last year, Wall Street secured $20 billion in subprime auto loans!)

Although the Fed has been unable to do much about the real economy… in the financial economy it’s wrought wonders! That’s the secret to understanding the markets, Duncan explains. It depends on the difference between how much credit the economy needs and how much it gets. The excess is what drives up asset prices.

The Rich Get Richer

That’s why the rich have gotten so rich lately…

The markets take excess credit and use it to bid up asset prices. Stocks rise. Real estate prices go up. (The average house price is back at over $200,000.)

Household net worth – heavily concentrated in the upper reaches of the socio-economic pyramid – rose $8 trillion in the last 12 months. It’s now greater than it was in 2007. And that huge increase appears to be the only thing keeping the economy from sinking.

Take away the QE, and you take the biggest single buyer out of the bond market. Bond prices fall (and yields rise). Stocks fall. Housing prices fall. And the economy, no longer buoyed up by the phony “wealth effect,” is suddenly pulled under by a real “poverty effect.”

Duncan tells us that all borrowers put together are likely to ask for $2.2 trillion worth of credit this year. That is a 3.8% increase. But that’s before inflation. Take off 2% for rising prices, and the real increase falls short of the 2% needed to avoid recession.

So, here’s what happens. The Fed has to keep peddling cheap credit, or the economy falls into recession. Some of it is absorbed by the bond market (mostly US federal deficits). Anything more than is needed to fund credit demands is the “excess liquidity” that drives the asset markets. Stocks soared in 2013 because the Fed overfunded US credit demands (the US budget deficit declined).

“The Fed is driving the economy,” says Duncan.

The feds broke it. Now, they own it.

Over the next six months, Duncan sees no problem. There will be enough excess liquidity to keep asset prices moving up.

But then, watch out.



4 thoughts on “WHY QE WILL NOT BE TAPERED”

  1. Seven devastating economic facts: http://www.breitbart.com/Big-Government/2014/01/15/7-Devastating-Economic-Facts

    Since Jan. 2009, the Number of Jobless Working-Age Americans Has Risen 9.6 Million People

    Nearly One in Three Americans Fell into Poverty Between 2009-2011

    A new Census Bureau report released last week found that 31.6% of Americans fell beneath the federal poverty line for at least two months between 2009 to 2011, a 4.5% increase over the 2005 to 2007 period.

  2. I went to buy a down jacket this week-end….150 bucks….DAMN even the price of down was UP !

    Yah’ know I told everyone in 2010…”The End Is Near “….made me look stupid to my unprepared friends now that the “End” has happened yet. I guess eventually I’ll have the last laugh .

  3. I often wonder how many people, even jaded and skeptical if not outright doomers will stay in this market trying to coax another 4 percent outta their investments thinking – ‘I get it, and I’ll be gone when it starts getting ugly’ only to find they’re fucked….the doors are locked.

    In my particular vocation, I talk to lots of people from all around. Crime, gangs, drugs, and no/poor quality jobs…in all of your favorite places. Its like there’s two America’s these days, the ones who know and the others who don’t.

  4. I’ll stay in this market for only one thing. Well, maybe two..

    #1 is TBF and #2 is TBX (ETF’s to short 20 and 10 year Treasuries).. As they bump along the bottom, I just pick up some now and then just to comfort me. Doesn’t earn a dime but sooner or later (and I’m very patient) those two plus SJB (ETF to short junk bonds) will make me a top 5%er and I shall give all my TBP friends a big “Thhhiiiibbbbit” coupled with noises of vault opening (a’la Jack Benny – remember? If you don’t, fuck you!) to allow me to store all the Au and Ag I can find from the proceeds.

    If it doesn’t happen until after I’m dead, my successor Trustee has firm direction on doing the same damn thing.


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