Thinking The Unthinkable

The Royal Bank of Scotland, essentially a UK-government institution following its nationalization during the recent bank crisis, is warning that we’re on the verge of a major economic meltdown: “We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable.” Report in the Telegraph:

As recovery starts to stall in the US and Europe with echoes of mid-1931, bond experts are once again dusting off a speech by Ben Bernanke given eight years ago as a freshman governor at the Federal Reserve.

Entitled “Deflation: Making Sure It Doesn’t Happen Here“, it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy.

The speech is best known for its irreverent one-liner: “The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost.”

Bernanke began putting the script into action after the credit system seized up in 2008, purchasing $1.75 trillion of Treasuries, mortgage securities, and agency bonds to shore up the US credit system. He stopped far short of the $5 trillion balance sheet quietly pencilled in by the Fed Board as the upper limit for quantitative easing (QE).

Investors basking in Wall Street’s V-shaped rally had assumed that this bizarre episode was over. So did the Fed, which has been shutting liquidity spigots one by one. But the latest batch of data is disturbing.

The ECRI leading indicator produced by the Economic Cycle Research Institute plummeted yet again last week to -6.9, pointing to contraction in the US by the end of the year. It is dropping faster that at any time in the post-War era.

The latest data from the CPB Netherlands Bureau shows that world trade slid 1.7pc in May, with the biggest fall in Asia. The Baltic Dry Index measuring freight rates on bulk goods has dropped 40pc in a month. This is a volatile index that can be distorted by the supply of new ships, but those who watch it as an early warning signal for China and commodities are nervous.

Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on “monster” quantitative easing (QE)”.

“We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable,” he said in a note to investors.

Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option “which I personally prefer”.

A recent paper by the San Francisco Fed argues that interest rates should now be minus 5pc under the bank’s “rule of thumb” measure of capacity use and unemployment. The rate is currently minus 2pc when QE is factored in. You could conclude, very crudely, that the Fed must therefore buy another $2 trillion of bonds, and even more if Europe’s EMU debacle goes from bad to worse. I suspect that this hints at the Bernanke view, but it is anathema to hardliners at the Kansas, Richmond, Philadephia, and Dallas Feds.

Societe Generale’s uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the “stinking fiscal mess” across the developed world. “The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant,” he said…

[continues in the Telegraph]

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  • Cerebralcaustic

    True free-market advocates predicted the current economic crisis hundreds of years ago:

    Though the principles of the banking trade may appear somewhat abstruse, the practice is capable of being reduced to strict rules. To depart upon any occasion from these rules, in consequence of some flattering speculation of extraordinary gain, is almost always extremely dangerous, and frequently fatal to the banking company which attempts it.

    Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book V, Chapter I, Part III (1776)

  • airborne11

    http://www.thedebtrealignmentinitiative.com/Hom

    What do people think about this guy's idea? I don't see why it couldn't work, though admittedly I am not an expert in these matters. Perhaps it could work and that is why They will not give him the time of day…

  • http://www.thecarnivalnoir.com Haystack

    I can't claim to understand economics well enough to make a positive prediction about the future, but watching analogs to the US banking crisis happen elsewhere, such as the Greece/Eurozone crisis, signals to me that it was more than a one-time fluke, and that the people who are in charge are not as in control as we'd like them to be.

    A lot of it seems to boil down to the fact that the West hasn't woken up to the fact that it no longer has the wealth to support its standard of living.

    If the unthinkable happens, it may not be the worst thing. It's not as bad getting poor if everyone else is getting poor with you, and consumerism really has become a disease.

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