Debt Deflation V Credit Deflation

The Bank of International Settlements (BIS) is the hub of all the central banks, the holy of holies among the powers that be.  The FED may be the chief priest, but the BIS is the Sanhedrin.

When their policy wonks put out a study, it does well to read it to see what they know and think.  They can only work within their own narrative.

Well, it turns out there are quite well apprised of what is going on....  and what they have to say is -

1. Credit deflation is happening, and there is a flip side, a good side, for small business etc.

2. If you depend on paycheck, property or pension, you are toast.  For the next 25-40 years at least.

What have I been saying?

You can read it here, it opens as a .pdf.

Some excerpts:

 And even if deflation is seen as a cause, rather than a symptom, of economic
conditions, its effects are not obvious. On the one hand, deflation can indeed
reduce output. Rigid nominal wages may aggravate unemployment. Falling prices
raise the real value of debt, undermining borrowers’ balance sheets, both public and
private – a prominent concern at present given historically high debt levels.
Consumers might delay spending, in anticipation of lower prices. And if interest
rates hit the zero lower bound, monetary policy will struggle to encourage
spending. On the other hand, deflation may actually boost output. Lower prices
 increase real incomes and wealth. And they may also make export goods more
competitive.2

Rigid nominal wages?  Start-ups paying less when less buys more will crush standing businesses paying more.  The $1 an hour more at WalMart and McD was exactly the wrong move, for them.

And then your mortgage becomes sisyphean, you can't afford the mortgage as time goes on...   the asset value regresses to the mean, ouch.    Most will simply jingle-mail, walk away.  And smart people will rent for 20 years and lower the rent on the landlord every year.  Right of first refusal will become popular in rental contracts.

There are two sides to every policy, a winner and a loser.    What Mish and I call credit deflation, the BIS lads are calling from their perspective, the other side, debt deflation. Two sides of the same coin.  Now these lads get it, but note the see the top policy folks still do not get it.   This is important, and good, meaning they will screw it up even more to small business advantage.

His envisaged mechanism, however, operates fundamentally through the impact of the liquidation
and repayment of debt on the money supply (deposit money) and, from there, on prices. Empirical
evidence for the relevance of debt deflation more generally is scant and anecdotal. In their
econometric analysis of the Great Depression, Bernanke and James (1991) do not include debt
deflation explicitly; they simply suggest that the (large) unexplained component in the output
contraction in a sample of countries may reflect its operation. Fackler and Parker (2005) infer the
relevance of debt deflation in the United States from the observation that debt grew rapidly in the
1920s against the backdrop of largely stable prices. That same observation, alongside the strong
increase in asset prices, led Eichengreen and Mitchener (2003), drawing on Borio and Lowe (2002),
to argue that the Great Depression was a credit boom gone wrong – a point subsequently
confirmed by Schularick and Taylor (2012). Meltzer (2003), in turn, argues against the debt deflation
view on the grounds that the fall in goods and services prices should have boosted real balances
and stimulated spending. He sees tight monetary policy as the main cause, as had already been
highlighted by Friedman and Schwartz (1963).

And Friedman and Schwartz were wrong, and Friedman said so before he died.  Unh!  Where are my notes on that!

 Against the background of record high levels of both public and private
debt (Graph 7), a key concern about the output costs of goods and services price
deflation in the current debate is “debt deflation”, ie the interaction of deflation with
debt. The idea is that, as prices fall, the real debt burden of borrowers increases,
inducing spending cutbacks and possibly defaults. This harks back to Fisher (1933),
who coined the term.16  Fisher’s concern was with businesses; today the focus is as
strong, if not stronger, on households and the public sector. This type of debt
deflation should be distinguished from the strains on balance sheets induced by
asset price  deflations.

Yes, distinguish between business debt and household debt.  but business debt problem is your pension assets, including social security hopes, since that is a ponzi scheme depending on the greater fool presently paying in from industry jobs.

So they know, at least at the wonk level, credit deflation, or form the hegemon's perspective, debt deflation, hammers the assets of the powers that be and their selected winners.  It open up opportunity for the small business, by lowering costs of labor and inputs and real estate, while the prices of all things is going down.

If you have your $15 an hour job (or more), in a prime real estate office space, with a wonderful 401K, and a mortgage on a nice house, you are toast because competitors can provide jobs to people who can gain more with less money, whereas you need to maintain status quo on all fronts to maintain your debt based economic status. Your law firm goes down.  Your biotech goes down.  Your real estate office goes down.  Your bank goes down.

Be agile, nimble.  Get a business going, so you can abandon the sinking ship and rebuild after the Spanish Armada like disaster we are sailing into...

And money does not matter, nor gold, credit is the thing.  Extend usury-free asset-backed credit to your customers.  The longer they take to pay, the richer you get.  The game has reversed, and the powers that be, at least their wonks, know it.

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Credit Hyperinflation & Deflation

John, forgive the ignorance but what do you exaclty with the term "credit deflation"?
Shouldn´t be the other way around (inflation)? due to the QE of the FED?
Thanks

Please know I use the tactic of taking a definite opinion on any topic which interests, especially with a view to provoke contradiction.  My thesis invites antithesis, from which I may form syntheses, and ever go deeper into topics.

I am dead wrong about credit deflation.  I fused Mish Shedlock's victory in a debate among Austrian economics over hyperinflation, especially with Dr. Gary North, with Shedlock's other unique contribution that the role of credit in the markets (properly defined) was the reason that we had not had hyperinflation in currency, plus Dr. Frank Shostak's  (and others) delineation of "good credit" and "bad credit."

My thesis was initially we are in credit deflation.  Implicit in your question is the awareness "credit deflation" is incoherent in these circumstances.  You are right.  Now my thesis is we are experiencing credit hyperinflation.

What do we have?  In the asset category of bad credit, we have hyperinflation.  They created so much of it, it is absolutely worthless, except in wiped out categories: equities, education, health care and housing.  Look at the trillions in fake stock values, another trillion is pointless student loan (and non-bankruptable) student loan debt, billions in auto loan debt which cannot be repaid, ever more overcharging for risible health care, and of course the ridiculous price of houses, ginned up by the extension of bad credit.  This is a large part of the economy, and debt for which there are claims, but will never be paid.  Expect fights, but know all the assets listed will go for pennies on the dollar very soon.

There is good credit, asset backed, at no interest, which is in such small amounts in each instance that it is incalculable.  This will actually rise in value.  This will also grow at teh small business level.

Hyperinflation is a monetary event in which when they print too much currency, you have too many dollars chasing a static amount of goods.  Prices appear to rise, but the effect is theft from the last people to get the new currency.

Hyperinflation in credit is a monetary event in which when they extend too much credit, you have too much credit chasing a static amount of goods.  Prices appear to rise, but the effect is theft from the last people to get the new credit.

GE knows this game is over and got rid of its "bad credit" machine.  There will be a categorical crash in this part of the economy.

They did not print too much currency.  That is still good.  The proof is they are trying to call it in (when you deposit your money in the bank, your money is owned by the bank, not you... that is the law) force you to use, if not bad credit, debit cards and they have begun outlawing storing cash in safety deposit boxes.  

Before 1913, any bank would issue its own currency, and after 1913 that is still the legal fiction, but by law you must only use the Federal Reserve Notes.  Deregulating banking would cure our economic ills, but wipe out all of the bad economy.  That would take out the powers that be, and the military would have to return to a defensive force.  Ain't gonna happen.

So now that the powers that be have run out of "policy options", that is they can neither do any good nor bad, they are now just rent collectors, who can put people in jail.

Asset-less credit extension is neither necessary nor sufficient in the part of the economy that is productive, and creating economic value in the productive part of the will be a matter of discipline.  Vast swathes of America and Americans cannot be your customers because they are willfully unproductive.  Entitlement on the part of the rich and poor will cause them to fight over the rents from that very thin film of productive assets to which astronomical claims are attached.

On the other hand, it is easy to spot your customers, by their patterns and practices in economic activity, one crucial aspect is do they extend credit against assets in their business dealings?  (And by implication, check the creditworthiness of their customers, meaning the personally grant and refuse credit.)

Credit is important, what kind of credit is important, how it is employed is important, far more than money.  if there is one skill that now needs to be learned, it is this.  Although this skill was becoming useless when I first started, I am glad I learned it, because demand for this skill is roaring back.

The world changed the last three months.


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Are Negative Interest Rates Debt Deflation?

I've repented of using the terms malcredit and benecredit, since modifying perfectly good words to account for degeneration cedes ground to the bad guys.  There are apples, and there are rotten apples. There is credit, and then there is ex nihilo credit.  Clear and simple.

Credit and debt necessarily balance out.  If I lend you $20, you owe me $20. Everbody does that.  It is not ex nihilo, cuz if I am not paid back, I've lost $20 in purchasing power.  This is private extension of credit, and there is a debt on the other side.

If I ship you $500 in goods at net 30, you owe me $500, and I have an accounts receivable, an asset, worth $500.  If you don't pay, I am out my income, and the books I sold you. This is commercial extension of credit, and there is a debt on the other side.

That's all just credit.  And debt. At no interest.  All good.

Now, sometimes, some people would extend their $20 at interest. In most of history, this was illegitimate, if not illegal, since lending any amount at any rate of interest for any duration causes damage.    People lending at interest had no recourse to courts for enforcement, any more than a casino operator can enforce gambling debts (hence extra-legal enforcement of gambling debts).

In any event, credit is good, but it can be abused by adding interest.

Now banks, where gold and silver were stored, at first could not lend out their stores, for example, it was illegal in ancient Rome.  In time things change, so just like I might lend you $20, a bank could too. OK, if the owner of the deposit agreed.

But the temptation to lend money out at interest is of course just too strong.  So that happened.   It distorts an economy, but that is not as bad as it can get.

Instead of releasing gold as a loan, the depositor could write a note stating the note-holder was as good as gold.  These notes could move around, the proto-currency.    Nothing wrong with that.  It's a loan, and there is an asset on the other side.  But of course it also could have interest attached.

One currency happened, bankers figured out they could write more currency than there was gold, initially a crime that carried the death penalty.  We call this fractional reserve banking now.   In the measure there is only a fraction of reserve backing loans, that measure is ex nihilo credit.  If your bank holds 100 pounds of gold, and you write 200 pounds in currency notes, then you have a 50% fractional reserve.  Of course this is fraud, and "bank runs" followed discovery.  If ruined depositors did not kill the bankers, it was only because he authorities hanged them first.

Things change.  It's quite common for what is criminal among citizens becomes de riguer for the Hegemon.  Now our entire banking system worldwide is built on fractional reserve, hard to say exactly, but best estimates is 3%.  97% ex nihilo. Fractional reserve is so dicey it is stupid without some insurance premium so to speak, and that is interest on the loans of the fractionally reserved credit.

So imagine that.  For the portion of the economy which depends on bank credit, some 97% is ex nihilo credit.  There is a debt on one side, but no asset underlying credit on the other side.

It sounds like there is.  Ford got credited ex nihilo for the Mustang of which title was transferred to you, upon your promise to make payments, in ex nihilo credit, plus interest, out of your income stream, largely tallied in ex nihilo credit.  Whole lotta ex nihilo credit going' round.  Ford is zeroed out, the bank is zeroed out, you've got a Mustang and payments.  What's wrong with that?

Before I explain what's wrong with that, let me translate the previous paragraph from reality to capitalism.

You get a loan from a bank for the money to buy a Ford Mustang. Ford gets that money for the Mustang and transfers title to you, upon your promise to make payments, in money, plus interest, out of your income stream.  Ford is zeroed out, the bank is zeroed out, you've got a Mustang and payments.  What's wrong with that?

Well, it's not money.  (But experience the social conditioning: the second version sounds correct, but it is utter fiction.) It's ex nihilo credit. It suggests a wealth that is not there, and people calculate economic decisions in prices, prices that are not denominated in money, but in ex nihilo credit.

Ex nihilo credit has no rational limit.  Ex nihilo credit appears to be wealth.  People who would not qualify for asset backed loans certainly qualify for ex nihilo credit.  They want more better cheaper faster, and as ex nihilo credit-based demand grows,  Ford can deliver, at least what is advertised as such.

What's wrong with that?  Well, as Bastiat noted, there is the seen and unseen.  We like what we see.  And as I note, we all love a system that works for us.

Ex nihilo credit is paid into the economy, causing inflation, and an appearance of wealth that is not there.  People overextend.

With false wealth, the most egregious borrowers are necessarily calling forth what array of goods and services we see.  The least perspicacious are the most powerful economic actors, given the leverage ex nihilo credit offers. A Dick Cheney tells us "deficits do not matter" (ex nihilo credit is also deficit spending) as he gleefully prosecutes criminal wars with impunity, and immunity.  The poorest person in USA can whip out his EBT card to pay for a couple of corn dogs and a supersized Coke at a gas station. There is no difference in kind between those two people, only in scale. Neither has any money.  Both are dependent on ex nihilo credit.  Both are economic actors. Both simply put their purchases on the tab denominated in ex nihilo credit.  It all adds to the power, denominated in ex nihilo credit tallies, of the bankers, etc.

Sure auto payment delinquencies are up, but only to 2.6%.  So what?

On the margin, much of the recent growth of auto sales has been attributable to sub-prime borrowers, which are now up to 31% of all loans. These loans carry onerous interest rates—often 20% or more—-and are available primarily due to junk debt financing of non-bank lenders. That is, fly-by-night start-ups organized by Wall Street and private equity funds.

What is unseen is what that 31% would be buying if they were not

A. using credit or money to buy a car (public transportation?  different car?)

B. forking over the 20% interest on their ex nihilo credit loan to the bankers.  We'll never know.  the only thing we do know, is they cannot afford to what they are "buying" with ex nihilo credit.

Their losses go on our tabs.  Recall it is ex nihilo credit, the banks are out nothing. The delinquent buyer may have a note on a credit score, but Ford has the $35,000 in ex nihilo credit on the books as an asset.  Where is the asset underlying the deal?  Why, the Mustang itself, right?  Well, it's been repo'd and sold for $20,000. That's a $15,000 difference.  Is the bank out?  No.....  Is Ford out?  No....  Is the borrower out?  No....  well, then who picks up the $15,000 loss?  If you cannot tell who is the mark in a poker game within the first 20 seconds, it's you.

Hi Ho Hi Ho, it's off to work you go...  You have to work to pay down the tab of everyone from Dick Cheney to the delinquent Mustang short-faller to the unemployed fellow dining on corn-syrup dogs and diabetes-bev at the Mini-mart.  That's capitalism.

What is unseen is what we would have without ex nihilo credit.  Less war?  Less surveillance?  Better medicine, education, clothing, food, housing?    More peace and prosperity?  History says yes, but we see the Mustang in the driveway and say "what's wrong with that?"

We all love a system that works for us. 150 years ago the English would look at the Irish for whom the system did not extend, dining on the 1850s version of corndog and coke, and say they are genetically inferior.   Today we look at those who do so and say the same things.

Ex nihilo credit distorts the array of goods and services we would reckon we could buy.

It retards true wealth creation by tapping into income streams with interest payments.

It concentrates wealth in ever fewer hands, by means of interest stream if no default, and titles returned to the lenders if default, who in turn then hold sway over those who borrowed ex nihilo credit (we've noted in your file), if not enslave them as with student loans.

What do we care?  We have big screen TV, KFC, Mustang, iPhone and a house.  And Romney/Obamacare.  And poverty draft.

Well, you might not care, but the 1% are sure worried.  There was no rational limit to lending ex nihilo credit at interest.  But something that defies understanding, never seen before in history, is happening.  An utterly irrational negative interest rate phenomenon.  With wealth tallied in ex nihilo credit, an undoing could result in all tallies being marked to market.  Pro rata?  Or politically distributed (OK, I know the answer.)  Or war?  If the 1% is worried, you should, because they decide.

Inflation comes from printing too much currency.  We have inflation in housing, medicine, education, some categories of food, and certainly equities.  So what happens when you "print too much credit," or more accurately too much ex nihilo credit?  That is the head scratcher.  Deflation?  We do see prices dropping in shipping, but that is overcapacity based on misallocation of resources and malinvestment due to reckoning prices in ex nihilo credit. Dropping prices is not necessarily deflation.

Perhaps deflation in relation to ex nihilo credit is not in the price of goods, but the price of debt.  The negative interest rates are showing up in bonds, in other words, debt.  So if we had hyperinflation of credit with ex nihilo incontinence, is the reverse hyper-deflation in debt?

Is negative 2/10th of 1% interest on a ten year bond an abberation, or just the beginning?  We can see various actors chafing with ten trillion at negative 2/10ths of 1%. Has anyone studied the impact of negative interest rates to 2%, 5, 10, 25%?    Is that the denouement?  Deflation in debt, the debt on the other side of the balance sheet for ex nihilo credit?

If the hegemon's power is tallied in ex nihilo credit-based debt (for the one who holds the paper is in control) the debt deflation means a commensurate loss of power.  Is that what is going on?  You tell me, I haven't figures it out yet.

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Alternative Currencies

You could not present me a more painful opportunity.   Now capitalism has had it, the worm has turned, as anyone who reads this blog regularly knows I believe credit deflation will be as dominant the next forty years and credit inflation was the last.  Credit inflation is evil, and deflation is the corrective.  This means the action of credit deflation will regress to the mean, that is to say go much farther that back to normal in its correction course.  in short, the exploiters who grew in credit inflation are going to lose more than they gained in the game.

Further, credit inflation was programmed in and managed.  Those playing that game for the last 40 years did quite well materially.  Sadly, it concentrated buying power in ever fewer hands, while crowding out the good that might have been, absent the malinvestment and misallocation of credit inflation.

But credit deflation is unmanageable.  The powers that be can do nothing about it.  You can force people to borrow by having a half-dozen conspirators cut a $4 billion bond deal to try to cut a useless tunnel through mud under Seattle, but a some point there are no buyers for the $4 billion in bonds, since the income stream to repay the bonds is doubtful.  We are there.

Unable to crush small businesses by cheapo EZ credit on long terms to buy massive quantity, and extend expensive credit to customers, McDonalds can no longer expand, nor can IKEA, or Best Buy, Walgreens or Lowes or Office Depot.  Walk through any of the above, and you can spot the problems - look how they are spacing product, the selection, and to the degree shopworn.  These stores have the wrong architecture, wrong computer systems, wrong location, wrong employees, and wrong business model for what is coming up.  Look for yourself, store closings, 2014 and 2015 already.

Look who is becoming big business: coffee and sandwich shops, liquidators and auto parts (DIY repair) and note how much the depend on overseas openings.

All this destruction at such a broad and deep swathe will create a vacuum into which small business can grow.  With credit deflation, the necessary vacuum at the small business level needs banking to match the opportunity, and even the savings and loans are out of the question...  we need a private credit (not monetary system) independent of the hegemon's lockdown, capitalist-exploitative system.  It needs to be usury (interest-free).  It needs to be focussed on members, and support manufacturing, quality construction, specialty services, the very victims of credit inflation.  it would be a good idea, but presently such initiatives are extremely marginal, like Kiva Zip and community sourced capital.

Are such efforts scaleable? Yes!

http://en.wikipedia.org/wiki/WIR_Bank

Small business, independent credit, interest-free...  founded in economic hard times...  counter-cyclical...

According to the article, interest-free for the first 18 years...

WIR was founded in 1934 by businessmen Werner Zimmermann and Paul Enz as a result of currency shortages and global financial instability. A banking license was granted in 1936.^[1] Both Zimmermann and Enz had been influenced by German libertarian economistSilvio Gesell;^[2] however, the WIR Bank renounced Gesell's "free money" theory in 1952, opening the door to monetary interest.^[3]

The article does have some questions...

Is the WIR Franc Interest bearing or interest free? The article says: "the WIR Bank renounced Gesell's 'free money' theory in 1952, opening the door to monetary interest" and then later says: "These WIR obligations being interest free have a cost of zero" Thanks! --
Is the WIR Franc Interest bearing or interest free? The article says: "the WIR Bank renounced Gesell's 'free money' theory in 1952, opening the door to monetary interest" and then later says: "These WIR obligations being interest free have a cost of zero" Thanks! --Lbeaumont (talk) 14:52, 23 January 2014 (UTC)

But that is the thing.... If you are a young scholar interested in finance, make this your phd study... as Wayne Gretsky said, "just be where the hockey puck is going next" so if you are interested in banking, study this.

For those of us in business, here is a working model we need to adapt in the USA.  This is all free market stuff, and in capitalism it is mostly criminal since the patterns and practices are against freedom, economic justice, peace and prosperity.  Just look around.

But proceed we must, and see how far an independent credit system within the hegemon's borders can go.  WE can have everything good without the hegemon's credit inflation scam, we just need freedom.

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McDonald's Turn-Around Fails, So They Repeat, P&G Losing Too

The great credit deflation wipe out continues:

While those 700 store closings this year represent a fraction of the 32,500 or so restaurants worldwide, they show how aggressive McDonald’s is getting in pruning poorly attended locations that are dragging down its results.

That is about 1 in 50 stores.  A couple months ago they said 350, now it turns out 700.  This is not the end of it, just the beginning. That is massive sales volume that will be spent elsewhere.  They claim it is an Asian food scare...  how about Asian food awareness?

Earlier on Wednesday, McDonald’s hadreported an 11% decrease in revenue and a 30% drop in profit for the first three months of year, a continuation of its troubles in the last two years as it has struggled to compete with new U.S. competitors, a tough economy in Europe and a food safety scare in Asia.

McDonalds knows what its customers want, but it cannot meet demand with the infrastructure, branding, pipelines that McD owns:

For instance, earlier in April the companyannounced it is testing out a larger, pricier, third-of-a-pound burger for $5, two years after dropping the similar Angus burger line because they were too pricey for McDonald’s diners. Despite that earlier failure, new CEO Steve Easterbrook expressed confidence his customers would go for premium burgers.

Now that is creativity, try again what you know will fail.  Into this void small business can organize to bring customers exactly what they want.  The world is cracking open.

The next dinosaur to feel the cold is Proctor and Gamble:

The maker of Tide detergent, Pampers diapers and Gillette razors reported net sales slipped 8% to $18.1 billion in the January-March quarter. Organic sales, which exclude currency swings and P&G’s recent divestitures, actually rose by 1% as sales grew or were at least even to last year’s level in four of five reporting segments. Higher prices broadly helped results. Core earnings slipped to 92 cents a share from $1 last year, though the bottom line would have increased by 10% excluding the stronger dollar.

Really, if USA is doing so well, how come they just gave the North American head the boot?  Temporizing by saying it is just the strong dollar is like Noah noticing the hatch is still open.

These huge companies depend on overseas sales to in effect launder their profits and escape USA taxation.  The larger the USA share, the more they pay in taxes, the less sales overseas, the less they escape taxes. The strong dollar is a by-product of credit-deflation.  For the dinosaurs, there is no way to respond in time.

The game the last 40 years is for Harvard MBA managers to get early inflated credit from Harvard MBA bankers and steamroll any competition, while proffering subsidized frankenfood (McD) and favorably regulated chemicals (P&G) to Harvard MBA cohort managers in government and industry overseas.  Write tax loopholes to allow the tax avoidance, and live high on the hog, ever concentrating wealth in fewer hands.

Lowes rolled up the neighborhood hardware store, Michael's rolled up the neighborhood five and dime,  Office Depot rolled up the neighborhood stationery store, Petco the neighborhood pet shop, Sears/Kmart (not long for this world) rolled up the neighborhood boutique, Blue Cross rolled up the neighborhood doctor, Union76 the corner gas station, McD the corner soda shop, CVS the neighborhood pharmacy, Safeway the corner grocer, BofA the neighborhood banker, and so on across the entire landscape.  Well, none of these dinosaurs can survive credit deflation, since credit inflation is entirely their DNA: size, systems, skillset, product assortment, logisitcs, all wrong for credit deflation.

These taxes, rules, regulations, banking, all of the judges, cops, armies, rolling stock, real estate, all of it is wrong for a natural economy, let alone an economy in credit deflation.  Too bad for Warren Buffet.  But excellent for anyone who starts up his own business.

Rules for the last forty years.

1. Get a steady paycheck with benefits.

2. Max the 401K and and other tax-avoidance programs as possible.

3. Get as prestigious a degree as you can gain with as much student loan as ppossible.

4. Get as much real estate as your credit rating will allow.

5. Keep your credit report clean.

Now -

1. Never be an employee.

2. Cash out your 401K, IRA etc, take the 30% tax and 10% hit, it will be far less a loss than what is coming.  Invest in your own business.  Compete on design not price.

3.  Skip the prestigious degree, no one is hiring anyway.  Get educated off the smorgasbord of what is available cheap and plentiful ed opportunities.

4. Own no real estate  Sell it off and rent as small as you can get by living in.  (Rural is the fasting growing section of USA in-migration.)

5. Extend credit to customers, at no interest.  Have no credit rating, let alone a good one.  In this way your assets are too hard to steal by uncle same.

Fifty years ago, when my brother in law laid out the first five, that was cutting edge thinking, and absolutely right.  It worked well for him.  Now things have changed.  If you understood the game 50 years ago, you did fine.  Understand the new game now.

Our Fortune 500 are experiencing chaos.  Like GE, they will all escape to anarchy.

That's my story and I am sticking to it, we'll see what happens the next couple of years.

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Lacy Hunt and Debt

Below is a very valuable 40 minute lecture on the current situation. The expert talking is a bond dealer, and he knows his stuff.  When Clinton was elected president, full of delusions of grandeur, he summoned the political leaders, the majority leader, the speaker of the house and others, to Arkansas to tell them how it was going to be.  The photos show a beaming Clinton welcoming his guests.  The next set of photos showed a somber Clinton at a farewell to these advisors.  (If anyone can find these..)

What happened at that meeting?

 At a meeting in Little Rock, Arkansas, Rubin and several other members of Clinton's economic team persuaded him to renege on this campaign pledge in favor of deficit reduction. They argued that tackling the deficit, which was then running at close to 5 percent of G.D.P., would impress the bond market, bring down long-term interest rates, and allow the Federal Reserve to cut short-term rates, all of which would boost investment and make the economy healthier. As Bob Woodward reported in his 1993 book, The Agenda, Clinton was initially skeptical of this argument. His face turned red with anger and disbelief. "You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?" he said.

Yes, USA economy depends on debt, and debt dealers are commonly referred to in USA as #%çi#g bond traders.

Some capitalists will say the regime is abused and we get malinvestment and misallocation when the state picks winners and losers, by manipulating interest rates, lending credit when it is not backed by assets, and inflating the currency by printing too much. To be sure, all bad things, but they do not note the heart of capitalism which is irredeemably evil: charging interest on a loan.  All versions of capitalism depend on this one constant.

The problem with charging interest is the simple fact it is the perennial means of concentrating ever more economic power in ever fewer hands.  Now, no one denies this, the problem is just about everyone aspires to this.  Nothing new under the sun, most of us want to wield the whip, not take the stripes, fearing a false dichotomy.

Poor Michael Lewis, writing an expose´ on the heart of Wall Street, Liar's Poker, with a view to warning off the next generation from this casino of greed and economic abuse, was overwhelmed by Ivy League graduates all pleading for help getting a job doing what Lewis decried.

The communists noted the great threat of capitalism is when the system fails, as it inevitably does, the capitalists merely start a war, wipe out all of the malinvest and misallocation by bombing it to the stone age, then start over.  Not a bad observation.  And note the capitalists (as well as the communists) call all of this the free market.

Now, a pox on both their houses, the communists and capitalists.  For those of us trying to live genuinely productive lives, there are free markets, free from force and fraud, free to contract.  Free, free free! Would I outlaw usury (charging any rate of interest on any loan)?  No.  I would simply delegitimize it, meaning, should anyone who agreed to pay interest at any time could with impunity not pay it.  Like no court in USA will enforce a gambling debt. As a way to make money, it would shrivel up.

But without concentrating ever more power in ever fewer hands, we'd never have the iPhone!  You do not know that, nor do you see anything better that might be.

Businesses depend on credit!  True, it can be asset backed and private, or asset-less backed and public. The former is good, the latter is bad.  I recall when private asset backed credit came with no interest.  But once banks were allowed to lend asset-less backed credit, credit inflation was a powerful vacuum into which people could pay cash for a hamburger today, or buy a meal tens times as expensive today, and pay only the cost of the hamburger at the end of the month.  Yes, a debt at interest was created, but that is for the future.  Once this proved to be viable, banks in the 1970s began mass mailing live credit cards loaded with $500 limits.  At on point I have about 75 credit cards, for airlines, department stores, bank cards, AEX.  I just managed the balances.  Today people have maybe five, for the powers that be have consolidated banking and lending into ever fewer hands, concentrating power to the point it takes extremely few people to call the shots.  Now we manage the balances on five, instead of 75.  Capitalism marches on!

This expansion of credit, and Mish is one of the first and only to note it, caused credit inflation, a version of the monetary event that occurs when you print too much currency.  Rothbard notes inflation benefits the first to get the excess money, and by analogy this is true of credit.

We are not any longer in credit inflation, we are in credit deflation.  This is news only to people in government, those outside are quite well aware of this.

So what makes the video below very important is, the first time I've heard it said, that deflation of asset-less backed credit has the reverse effect of inflationary asset-less backed credit.  This guy would know: PhD Temple, worked for Rockefeller at Chase, headed up HSBC economics dept when HSBC was the largest bank in the world, and so on... now managed $6 billion in bonds for pensions out of his home in Texas.

Here is his big point:  When deflation is 2%, and the bond yield is 2%, you are netting 4%.  To chase yield by buying junkier bonds at 4% is delusional since those two points are not covering the risk premium.  Even at 2 + 4 = 6 what's available is junk.  (Guess what you pension is loaded up with.)   But but but, it's all rated triple A!  (So you are falling for the bought-off rating agencies scam AGAIN?!) (And as a bond dealer he has nothing to say about equities, currently a fools game.)  You are being scammed into buying junk by dealers who point out the nominal rates, not noting the structural rates.  But so what, those who invest in bonds deserve what they get, the more useful info to we in small business is his other points:

1. The winner in deflation is the opposite of the inflation winner: the last person to get paid is paid in harder dollars.

2. The lowest actors can deal in harder assets (gold instead of currency, currency instead of credit) and benefit the most.  Mr. Hunt notes businesses will rather keep their cash receipts in the safe and pay workers cash from the vault, than keep money in the bank, just like when I was a kid.

So what you need to listen to is his explication of how deflation works, now that we are in it.

In essence, what I have been advocating, extending non-usury credit at retail and wholesale to customers, as an ethical matter, means now in deflation when you do get paid in 30 days, while we are in deflation, you are getting paid later in harder dollars.  The rule of 72 in operative: at 2% deflation, your wealth (the float as accounts receivable) has doubled doing nothing over your career, say 36 years.

Going back to pay packets instead of paychecks is not only a good thing, it is smart money management.

And think about it: more customers will prefer to simply sign for their goods than put it on an interest bearing loan card. They think you are doing them a favor, and you are making 2%, and not losing all those card fees.

Yes, you then have to manage credit, but when I was a kid "blackballed" and "86'd" were common terms.  I recall being asked while entering a shop by a bystander if I would buy something for the fellow, who offered the cash to do so, at the store since he was "blackballed."   Managing credit is a community thing, not a Washington/Wall Street axis of evil thing.

One minor point, Mr. Hunt says:

Three Problem Types of Debt  

1. Borrowing to finance daily living needs

1. Debt that leads to bankruptcy

1. Worst type of debt is where excess debt creation inflates asset prices.  And that only leads to economic instability.

"Good debt" to Lacy is debt that yields an income stream sufficient to pay back principal and interest.

The best debt is the non-interest bearing debt that undergirds all peaceful, prosperous and just comities, that is debt with no "income stream" attached.

Detroit is presently being bailed out in advance of the next crash by the extension of EZ auto credit to unqualified "buyers."

Student loan debt has surpassed credit card debt in USA, student loan debt is not bankruptable.  We lost 4-8 years of productivity while people went to school to learn skills they will never use and pile up debt they lived on and can never pay back.

Turns out those hundreds of billions banks risked to bail out countries has quietly been sold to European pensions.  (Note in the graph it says the banks create money to buy bonds from financial institutions.  Here again is where language has to be abused, for if this was stated accurately, it would reveal the delusion.  Accurate:  "Banks create credit, to buy credit."  If described accurately, it makes no sense, highlighting the delusional basis your pension is funded.  When your pension is useless, you cannot complain, because you wittingly bought into the delusion.

The hard part here is to go with the better unseen than the clearly malicious seen.

Check out this video, hat tip to Mish... it's a 40 minute seminar....



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Your House and Your Mustard

For as long as I can remember I whip up my hot mustard fresh from powder (cold water makes hot mustard), and have found Colman's a good brand of mustard powder to use, although bulk purchase is fine.  At Safeway in the spice aisle I gasped to see a 4 oz can of Colman's nearly $10!  Very odd, I recall from a few moments and aisles before that a 4 oz jar of hot prepared mustard was $1.79.  Hang on, powder is supposed to be cheaper than prepared,  like one fifth the price, not powdered five times as much!  This is chaos! What is going on?  What is going on is an excellent example of how inflation, and deflation, works.

First, inflation and deflation are strictly monetary events.  Then we immediately run into the problem of "how do you define money?" but for the purposes of illustration on this one point we can use the looser definitions without wandering into error.  In any any event, inflation is too much money, deflation is too little money, both monetary policy events.  Price increase is not necessarily inflation, nor is price decrease necessarily deflation.  For example, prices can increase in a disaster, and prices can decrease through efficiency, and neither is a monetary policy event.

Current circumstances also illustrate how inflation and deflation can be simultaneous and category specific, for example, how at the same time there can be deflation in housing, there can be inflation in food.

Credit mimics money, although it is not money.  Credit destruction is a mimic of money destruction, so it looks like deflation.  Housing is built on credit.  Credit is destructing, so housing prices are falling.

Food is based on cash.  Money markers (look-alikes) are being created, so prices are rising for cash things. (I know you pay by credit card, but credit cards get paid in 30 days, houses in 30 years.)

Now the trick of the FED is to fund bankers while taxing the middle class into oblivion.  How? Through creating "money."  You need to know how this works, how they nail you without you knowing, boil the frog slowly.  Whether you agree with the system or not, this is how it works.

Say today there are one million units of money, and bread costs 2 units.  And tomorrow the government doubles the amount of money, then eventually, all things being equal, that loaf of bread will double in price to 4 units.  Everything will double in price to absorb the new money. All things being equal, what would be the point?  It is all in the word eventually.

When the banks get the new money, they pay off their debts at the old prices.  OK, but what happens to the newly created money? It is still extra. The new money has not made it to you yet, the effect has not reached your loaf of bread. The new money, introduced at the banking level, will eventually make its way to you, in the vehicle of your paycheck.  But that money is filtered in first at the level of banks, then mines, fisheries and farms, parts manufacturers, finished goods manufacturers, retail and then last but not least, you. All along the process, those transactions absorbed more units of the funny money introduced earlier, raising prices as more money units were applied to the same portions in trade.

That filtration, over time (that word, eventually) means that the money that was created has been absorbed in all of those previous transactions and has resulted in the prices rising in those lower order goods, and eventually surprising you at the retail store, where you buy the higher order goods.  Fresher, faster turning, lower order 4 oz mustard powder is $10, and higher order prepared mustard 4 oz jar, in a jar and slower turning is $1.79.  This is precisely backwards!

Lower order powder packaged last week reflects the higher new costs, whereas the higher order prepared mustard packaged last year reflects the older costs of ingredients.  There are not many products offered in these two forms at retail, so it is a fairly unusual, but illustrative, example.

You can see the process in any Safeway.  When they do another mass run of prepared mustard at the new prices for raw materials, expect "mustard in a jar" prices to sky rocket.  Then it too will either be same price for lower sized jar, or inferior materials used (perhaps recycled Fukushima waste masquerading as mustard, as recycled aluminum smelter toxic waste is recycled as fluoride in USA water systems?)

For now you can see the price rise in the lower order goods making its way to the higher order goods.  Almost all of your purchases are of higher order goods, so you eat the loss from inflation, literally.  For the banks and big-biz/big-gov, inflation, this ruse, is a tax on the middle class that they cannot quite perceive.  Want to raise taxes on the middle class without a vote?  Create more money.

At the same time housing prices are falling.  It is a neat trick, because odious credit behaves like money substitutes.  As credit is destroyed, there is less credit to go around, so people accept less credit to cover the cost of a home, thus it takes fewer credit units to buy a home.  They talk "price" as if in money, but the real estate agent, buyer and banker mean credit.

So on one hand you must pay higher prices in the grocery store to fund the banks, in order that the bankers may be kept whole as the one largest investment in life, your home, goes disastrously down in value.  In a fascist state, the bankers must be immune to all risks.  So as they lose money with you on their stupid loans, only you must make them whole by paying too much at retail.

Your paycheck, pension and property are forfeit, and there is nothing you can do to stop that, except give them up, the sooner the better.  You will get more for them now than later. Then you secede in place by getting self employed.  It is your only defense.

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Your Credit Score & Credit Deflation

Usury is predatory, and your credit score is a reflection on how well you play the game.  High credit score, this means you are consider reliable in paying back loans (at interest, aka usury).  Is that a bad thing?

Well, yes.  The credit score is an assessment of how you play the game.  Do you take loans and then leverage them into payback?  Have you amassed enough personal wealth to be "good for it?"

Have you by insight or survivorship bias gained exceptional wealth through:

Wealth #1  Finance

Wealth # 2  Investment

Wealth #3  Real Estate

( F I R E )

All this is based on FED policy, and the FED has now run out of options, what we see is something new.  A mechanical reaction, credit deflation, largely misunderstood, to credit inflation, known perfectly well.

Low credit score means either you are not a good risk, or there is no history (because you neither take not make loans at interest.)  Is this a bad thing?  Well, no.

You just no better, and preferred not to get in the game.  Those who made money with F I R E are going to find the game no longer works as it did...  when that exceptional wealth evaporates, then what?

Watch credit deflation.  It's a fascinating new development.

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Chicago Schools - Credit Deflation

When existing credit is destroyed, you get credit deflation.  Chicago alone has billions denominated in asset-less backed credit, and it is moving into a crisis phase, from Mish:

Bad news on Chicago is deep and broad:

• The Chicago Public School System has a $1.1 Billion Budget Hole in $5.9 Billion Budget

• A $228 to $263 million derivative time bomb just triggered on the Chicago Board of Education

• Chicago Public Schools may be out of cash in 30 days

• Corruption investigations plague the school board

• Chicago booted Moody's as a bond rater

• Roadblocks impair pension reforms by the Illinois legislature

• Rauner issued a statement he will not bail out Chicago on the backs of Illinois taxpayers

• Chicago teachers threaten strikes demanding more money that isn't there

So when this fails, there will be a net re-assessment of values, and the billions that cannot be paid will not be paid...  BUT since the billions are denominated in credit, when it disappears (no pension check for you!) the economic impact will be credit deflation.

Whole lotta deflation goin' on....

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Inflation Bad, Deflation Good

This is in the comments and I want to elevate it to a post, from Sweden...

Precisely agree about inflation and banks. Inflation is the driving force behind all speculative business ventures. But deflation on the other hand is just the other side of the same coin. It creates incentives to hold cash instead of creating ideas that solve real problems. (I've got to study the Austrian school of economics, which I've just read about in your book, to be able to see where you're coming from.)

Bank comes from Italian and means table I've heard, as in the table they were counting coins in those times. Trading in the old times was simply goods traded for other goods. People sometimes forget that our systems today are not as universal as they seem. Studying a crisis that happened a decade or two ago won't solve the fundamental problem with the system. 

Inflation certainly invites speculation, which results in misallocation and malinvestment of credit (for we are beyond money now.)

Deflation can be the other side of the coin, in which the state begins withdraw currency, and fewer dollar chase the same goods, therefore, that which does sell sells for fewer units.  But there is another form of deflation, in which more better cheaper faster is produced so prices naturally fall.  For example in the cell phone or computer industry.  We all know in a few months the computers will be exponentially superior, but we all buy computers today.  Well aware of deflation in computers, no one waits or holds on to their money.

Deflation is an indication the market is free.  In a free market, which is inimicable to the state, all prices are constantly drifting down and we are constantly being offered more better cheaper faster.  So yes, state manipulation of the currency causing deflation is a bad thing, but no state wants deflation.  So what deflation we see is the natural kind, that should make us all happy, producers included, since they produce something narrow but buy from the entire market to meet their needs.

Another irony is deflationary free market eras are the most profitable for businesses because the perceived value of goods falls slower than deflation moves, thus widening profit margins.  So no one holds cash (money) in a deflationary era because there are the best profits to be had in business.

Now if you mean deflation causes people to hold credit, then yes, and in the Austrian school Dr. North and Mish Shedlock  have wrestled over this, with Mish noting few economists, even Austrians quite get this point.  (Mish says no inflation, North says hyperinflation.)  In essence, most Austrians say creating too much currency (credit in our system) causes hyperinflation.  Mish asks then how come not so far?  Mish says the currency is created, but it is parked on balance sheets, not being used.

Which makes our entire national balance sheet suspect.

So Mish has contributed to the discussion with his insights on money vs credit.

I've heard bank means shelf as to where gold was stored for people, although you may be right.  But as to trading in the old times was simply barter, we have barer today.  We had barter in the first records of man.  And certainly the Austrian canon says subsistence, barter, coins.

Graeber most recently and others going back have long noted that what is missing in the discussion is vendor financing, something very common today.  Any merchant, especially in B2B, will give his customers time to pay. See this point here...(especially the latter half where I get into vendor financing).

This is nothing new, it goes back to the Phoenicians trading with the Celts 500 BC.  For most of history, money was not in the deal.  It was all credit, as it is to this day.  So yes we do have examples of properly working economies going back to prehistoric times.  What has always been the case is the networks were so small that any failure was local and immediate and ended there and then.

What we have never seen before is every single transaction goes through a bank that is tied to every other bank, and the fractional reserve leveraging of credit to the point no one has any idea what the underlying assets are worth, nor who really owns what.  As recently as 150 years ago this was impossible for the simple reason contracts were not assignable.  No secondary markets to speak of.

The crises of a decade or two ago were simply warm-ups, test runs for what we have now.  Since no one went to prison for the PennCentral bailout, since no one went to prison for the Chrysler bailout, every economic crisis since then followed the same pattern and every time it got worse.  When the EU decides it needs to clip bank accounts in Cypress 10%, then we are very close to the end.

Yes, the system we have today is not universal, but it is different in scale, not kind.  So we can know what will happen.  And we do have responsible actors today, as we have had all through history.   We can go back to any point in history and see examples of how to do economies right, and how state intervention is always disastrous.

This system is failing, and is certainly past the point of no return.  This will not work itself out, and it will most likely result in the state changing the subject from its policy failure to war.  That too has always worked.

When we've been punished enough for our sins, among the survivors will be those who know how to do economies right.  Then the process starts over.

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Behalf Payment Systems

Well, this is easy... front run accounts receivable and make it up on collections...  and charge a pretty penny for the "competitive advantage" of pre-approved B2B credit approval. Something tells me the principals have never worked a trade show nor been in wholesale business to business.    All concept, no reality.

Here is the offer:

Behalf pays vendors upfront so that their small business customers can buy more and pay back on more flexible terms. 

But on credit deflation the longer before you are paid the harder the dollars. Buy more what?  Why do we ever need to buy more than is necessary?  The buying plan is designed to buy just the right amount.  And when you buy right, you can meet vendor terms standard in the industry.  Once you decide to farm out mission critical skillset, you are asking to fail.

The offer is to solve a problem that does not exist.

From a cash flow perspective, this phenomenon is mind-boggling – you are literally trying to plan and source your big season or entire years inventory in a matter of days. Even if you can afford it, what will that mean for your balance sheet? By spreading out your payments over time, you can both increase how much you buy, and better plan how you pay back.

Any buyer at a trade show without a buying plan is an idiot, and perhaps that is their intended market, idiots they can shake down coming and going.  All of the problems mentioned in the article are management problems, not finance problems.  You cannot pound a nail with a screwdriver.

I can't see where this gig will replace vendor financing or factors, the only two eternal offers.  And both management issues, not finance issues. The idea that the internet changed anything much is a delusion that just keeps precipitating the malinvestment and misallocation of resources.

Second, the website offers this:

This approach enables us to approve 30-40% of the small business market. That’s over 4x the approval rate of the credit card industry.

That is a false parity - why compare credit card risk approval at any rate, since taking credit cards as payment is to give up too many points in the transaction. And anyway, which credit card risk group is Behalf 4x the approval rate? Standard practice of checking B2B credit is about 80% approval rate, so what is attractive about Behalf's 1/2  as good performance? And

Suppliers across the U.S. use Behalf to transform purchase financing into a competitive weapon in their industry. On average, suppliers that use Behalf see a 20% increase in sales. 

Yes, increase sales and go out of business.  Suppliers building infrastructure to serve people soon to fail for outsourcing mission critical work leaves them malinvested and resources misallocated. Third:

Let us pay your customers’ invoices and reduce your accounts receivables. If your customer misses a payment to us, there is never any penalty to you.

I know I would set the algorithms to: pick sitting ducks we can skin.  Let sloppy people overbuy, and then nail them and be the first to shake them down.  They are going out of business at some point anyway, might as well the ones to clean them out.

Make it on fees on the front end, and then squeezing the late payers on the back end...  but it is too easy, the more creative work of business is more interesting than any of that.

Then this:

Behalf (beta.behalf.com), a small business financing company, backed by Sequoia and Spark Capital.

Good to know these VC funders, in essence elaborate pump and dump operations, have not become aware of the changes with credit deflation.  That they are backing a credit facility designed for an inflationary world when credit is in secular deflation means they are clueless.  Good to know.

I bet this venture fails to gain traction.  I'll be wrong when it gets acquired by google or amazon or some such (and right if it gets acquired by alibaba or microsoft).

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