economic depression

The Looming Threat of Credit Collapse and Deflation

by

THREAT OF CREDIT COLLAPSE 

The threat of a credit collapse and subsequent deflation currently outweigh the risks associated with higher inflation. This article explores the threat of a credit collapse and its implications for economies and societies worldwide.

After more than one hundred years of practicing inflation with intent and purpose, the Federal Reserve has backed themselves into a corner. The “dual mandate” objectives claimed by Chair Powell and his predecessors are little more than a smokescreen to hide the Fed’s scrambling efforts to contain the effects of the inflation which it has created over the past century.

In his latest attempt to divert attention away from the Fed, Powell has mentioned the potential negative effects of tariffs on the Fed’s efforts: “We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension.”

There should be no doubt that tariffs will be disruptive and harmful to the economy. Tariffs are self-inflicted wounds that have serious negative economic consequences. They do not work as intended or as described by their proponents.

That being said, it is important to consider the vulnerable state of the economy and the markets that existed before tariffs became front-page headlines. The fact of the matter is, that both financially and economically, the United States and the world stood at the edge of a precipice.

If someone pushes me from behind under ordinary circumstances, I might end up on the ground, but, I likely won’t suffer much damage. Then I could gather my thoughts, appraise the situation and stand up again.

What is currently happening is more closely akin to being pushed from behind while standing on one leg at the cliff’s edge. Even if the action were not malicious, the effects of the action cannot be rescinded or modified.

SIGNS OF THE TIMES

Universal credit default happens when individuals, corporations, and countries can no longer sustain the debt they have assumed on a scale that overwhelms ordinary financial and market activity.

This happened in 2008 with education loans, mortgages, and auto loans.  The price of non-performing debt sank into a deep hole, until the government and Federal Reserve embarked on a new experiment of making more and cheaper credit available and buying up the non-performing debt.

Now, almost two decades later, commercial real estate could be the trigger that sends the credit markets into a similar tailspin.

Sometimes, when stock prices decline badly, investors flee to the perceived safety of bonds. Unfortunately, that logic doesn’t work in reverse. If the bond market collapses, stocks will not provide a safe haven from the storm for bondholders. Currently, long-term bond prices (including Treasuries) are down fifty percent from their vaunted perch only three years ago.

As far as stock prices are concerned, we are currently experiencing the fourth decline of serious significance in this century. Previously, the stock market exhibited extreme volatility in 2000-02, 2007-09, and in 2020. While those extremes have not yet manifested this time, they could happen quickly.

We are possibly in the early stages of an asset price collapse. meaning all assets denominated in dollars – stocks, bonds, commodities, and real estate – are in danger of huge price declines.

That bad news is made worse because of bank failures. The worst financial and economic events in history were accompanied by bank failures. Bank failures were a common occurrence during the early 1930s and are evidence of the ongoing risks associated with fractional-reserve banking. Today, we have a system of no-reserve banking. There are no minimum reserve requirements for banks. How safe is your money? (see Fractional-Reserve Banking – Elephant In The Room)

DEFLATION 

Deflation is the opposite of inflation; it is a contraction in the supply of money and credit.

The effects of deflation result in fewer currency units (dollars) in circulation and an increase in purchasing power of the remaining units. In other words, your dollars will buy more – not less.

As the deflation takes hold, the prices of goods and services will decline, rather than increase. In and of itself, deflation can be a good thing. However, when deflation is severe enough, the result would be a catastrophic economic depression.

The depression will last longer than can be anticipated as it will take longer for the economy to cleanse itself of the ill effects of Federal Reserve inflation and mismanagement.

This is true even though the Federal Reserve and the government will do everything possible to counter the effects of deflation and depression. Unfortunately, their efforts will be overwhelmed by the tidal wave of financial and economic destruction headed our way.

CONCLUSION

President Trump and his tariffs are deserving of the blowback received. Chair Powell and the Fed deserve to share in the limelight for the decades of horrible financial and economic policies that have brought us to such a vulnerable state of affairs. (also see No Winners When The Inflation Balloon Pops and Liquidity Problems Could Overwhelm Inflation’s Effects)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Backtalk From The Bond Market

by

BACKTALK FROM THE BOND MARKET

Investors keep looking to the Fed for supposed “forward guidance”. They are looking in the wrong place. Since mid-December, bond prices have declined another 5% and are currently at new 52-week lows. Here is an updated chart of U.S. Treasury Bond ETF (TLT)…

U.S. Treasury bond prices have now declined 16% since the Fed announced a reversal in its interest rate policy and the first rate cut last September. The latest weakness comes in the face of a second rate cut, so it begs a repeat of the question I posed last October…
“Why are bond rates rising at the very time the Fed is trying to move interest rates lower?” (Fed Cuts Rates But Bond Rates Are RISING)
Subsequently, the Fed announced a second rate cut, but the announcement lacked the conviction that inflation is under control and that multiple rate cuts could be expected for 2025.
I don’t so much think the Fed has suddenly had a change of heart. The situation is precarious and the cumulative effects of more than full century of money creation (inflation), mis-management, and manipulation have evolved into a game of playing catch with a ticking time bomb.
Former Fed presidents Greenspan, Bernanke, and Yellen all know this and have kicked the can down the road. Jerome Powell was likely aware of the ongoing threat of a catastrophe from which there is no return. The opportunity to be “numero uno” for a season, however, must have displaced any fear of presiding over a credit collapse and economic depression.
THE FED’S DILEMMA

The Federal Reserve doesn’t know what to do; but it probably doesn’t make much difference anymore.

A dilemma is “a situation in which a difficult choice has to be made between two or more alternatives, especially equally undesirable ones.” (New Oxford American Dictionary)

We are hooked on low interest rates and the drug of cheap and easy credit. Maintaining low interest rates furthers that dependency and heightens the risk of overdose. The result would be a swift and renewed weakening of the U.S. dollar accompanied by the increasing effects of inflation.

On the other hand, raising interest rates more could trigger another credit implosion which could lead to deflation and a full-scale depression.

Doing nothing is an option. The problem is that the Fed is holding that “ticking time bomb” and doesn’t know how long it will be until its world blows apart.

WHAT TO EXPECT NEXT

Don’t trouble yourself worrying about who the next Fed chair will be. It doesn’t matter. It is too late in the game for a change to have any meaningful impact. This includes speculation that Judy Shelton might get nominated again. Yes, she is an excellent choice; and, for all of the right reasons.

Unfortunately, that would expose the game of chess being played by the Federal Reserve and its owners. (see Federal Reserve – Conspiracy Or Not? and Federal Reserve vs. Judy Shelton)

The worst possibilities come after something big happens. The Federal Reserve and the U.S. government will work together to stave off any possibility of loss of control. That means that everyone – investors,  traders, citizens, communities – will be subject to a host of new economic and monetary regulations, restrictions, executive orders, etc.

It will be like nothing we have seen in the past and beyond anything we can currently comprehend. (also see Bond Investors To The Fed – “Not This Time”)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

 

Default – Deflation – Depression

by

DEFAULT – DEFLATION – DEPRESSION

Inflation is the primary game plan of governments and central banks. Its effects have left their mark on societies throughout history. As the effects of inflation continue to dominate headlines, financial and economic activity is scrutinized and analyzed with the intent of planning, projecting, and predicting it.

Most people think they understand inflation – they don’t – but for now, let’s look the other way. There is a triple-decker bus coming straight at us.

Default can happen three different ways:

1) Credit default

2) Bank failures

3) Asset price collapse

Universal credit default happens when individuals, corporations, and countries can no longer sustain the debt they have assumed on a scale that overwhelms ordinary financial and market activity.

This happened in 2008 with education loans, mortgages, and auto loans.  The price of all this non-performing debt sank into a deep hole, until the government and Federal Reserve embarked on a new experiment of making more and cheaper credit available and buying up the non-performing debt.

Bank failures happen when banks violate the reserve requirements set by the Federal Reserve and are unable to meet the ongoing demand for money from their customers.

Bank failures were a common occurrence during the early 1930s and are evidence of the ongoing risks associated with fractional-reserve banking. (see Fractional-Reserve Banking – Elephant In The Room)

An asset price collapse is more often than not associated with stock prices. The stock market collapse in 1929 is the most prominent example; and it was a factor on three occasions in this century (2000-02, 2007-09, 2020).

An asset price collapse, however, includes all assets denominated in dollars and includes stocks, bonds, commodities, and real estate. We are currently in the early stages of another asset price collapse.

DEFLATION

Deflation is the opposite of inflation; it is a contraction in the supply of money and credit.

The effects of deflation result in fewer currency units (dollars) in circulation and an increase in purchasing power of the remaining units. In other words, your dollars will buy more – not less.

As the deflation takes hold, the prices of goods and services will decline, rather than increase. In and of itself, deflation is a good thing; however, when deflation is severe enough, the result would be a catastrophic economic depression.

Any single one, or combination, of the three types of default (credit default, bank failures, asset price collapse) can result in deflation. This happens because of the huge sums of money involved which are subsequently wiped out.

DEPRESSION

According to Investopedia, “A depression is a severe and prolonged downturn in economic activity.”

The stock market crash in 1929 did not cause the Great Depression. The Great Depression was the result of a flip-flop in Federal Reserve policy.

During the Roaring Twenties, the Fed pursued a generous approach to loans and interest rates. Because of concern about the rampant stock speculation fueled by their own generosity, the Fed became more restrictive and economic activity slowed. This slowdown in economic activity was underway before the stock market crash in October 1929.

It is quite possible that the Fed’s current efforts to raise interest rates could trigger a credit collapse, ushering in deflation and a New Great Depression. (see A Depression for the 21st Century)

MORE ABOUT DEFLATION, DEPRESSION

Deflation occurs when the system can no longer sustain itself on cheap and easy credit. The more aggressive the creation of the credit, the more horribly destructive are the effects of deflation when it occurs.

The effects of deflation are not nearly so subtle as those from the long years of inflation preceding it.

An implosion of the debt pyramid and destruction of credit would cause a settling of prices for everything (stocks, real estate, commodities, etc.) worldwide at anywhere from 50-90 percent less than current levels. It would translate to a very strong U.S. dollar and a much lower gold price.

The most severe effects would be felt in the credit markets and in any asset whose value is primarily determined and supported by the supply of credit available.

Conditions would be much worse than what we experienced in 2008-12.  The biggest difference would be that the changes would result in another Greater Depression on a scale most of us can’t imagine.  And the depression would likely last for years, maybe  decades.

CAN’T THE FED STOP DEFLATION?

They will try, of course, just as they tried and failed in the 1930s. The Great Depression lasted much longer than necessary because the U.S. government and the Fed persisted in efforts to counter the natural effects of deflation.

The effects of a credit collapse and deflation now would overwhelm any efforts by the Fed to re-inflate and stimulate.

The Federal Reserve, in its current attempt to avoid a complete and total rejection of the U.S. dollar, is trying to raise interest rates. Recent strength in the U.S. dollar indicates a measure of success thus far.

Unfortunately, the Fed’s efforts might backfire and trigger another credit collapse. In fact, a collapse might already be underway.

CONCLUSION

We are all hooked on the drug of cheap credit. But cheap credit was not buoying economic activity to the extent hoped for. Now, higher interest rates are choking off more of the activity that would normally have been there.

The Federal Reserve does not act preemptively. They are restricted by necessity to a policy of containment and reaction regarding the negative, implosive effects of their own making.

The problem is that the bond market is telling us that a credit collapse, deflation, and economic depression are on the horizon. The Fed knows this and can’t do anything about it.

The three Ds – default, deflation, depression – are upon us. If you are focusing on inflation, you need to look the other way.

(also see Effect Of Deflation On The Gold Price)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!