The definition of liquidity
I am encouraged to hear guests on CNBC like the ones I have linked to in my previous post. For CNBC to give these gentlemen this forum was quite surprising to me. Is it possible that the cheerleaders have some doubt their team is playing by the right rules? Druckenmiller uses terms that are slightly different than what I use to describe our problems, but he is right on. And he is obviously more qualified to render an opinion on the financial markets than I am.
So what is all this concern over liquidity in the markets about? Our central bankers believe they can implement certain monetary policies to stimulate the economy and hiring while keeping inflation in control. It is my belief that they really only delay the inevitable — but ultimately, their manipulation may well make the situation worse for the long-term. Easy credit through zero interest rate policy (ZIRP) and the creation of new money will stimulate financial markets, and even corporate profits in the short-term, but at some point their balance sheets will need to rebalance. It is always easy when you are spending more than you have. The tough times come when you have to pay off all those accumulated debts.
My theory is that the economy is geared toward a certain balance; you might look at it like gravitational pull. If you get too far off from center, sooner or later you will be pulled back to center. And the further you get away from center, the more force — like a stretched rubber-band — will pull you back to center — or even in the opposite direction.
What exactly am I referring to when I suggest we have manipulated our economy to keep it afloat? By far the policies of the Federal Reserve are most concerning: ZIRP has been unprecedented in both its duration and its “price fixing.” Since when has it been OK to manipulate interest rates in a free market? Interest rates are the most important fixture in free markets. If credit is no longer subject to the market forces of supply and demand, what is the proper price for credit? If the credit markets are referred to as the engine of our economy and we have thrown sawdust in the engine to make it sound like it is running OK, what happens over time? While the engine at one point might have been fixable, our sawdust has likely caused some permanent damage. The second problem with ZIRP is the very-targeted nature of the benefactors who are benefiting from this policy. Most predominantly, the benefactors are the too-big-to-fail banks, which clearly proved their maleficence during the 2008 collapse.
I’m also referring to the central bank’s more than tripling their balance sheet ($.89 trillion to more than $3 trillion). One of the most amazing things that has occurred is the fact that we are now the purchaser of our own debt as a nation — indefinitely! It is reported that the Federal Reserve is now purchasing about 80 percent of the treasuries issued by the U.S. government. They are also buying a half trillion dollars worth of mortgages every year. This, my friends, is not a free market; this is a hugely manipulated market and this is liquidity.
The Fed’s money printing and ZIRP is recognized by nearly everyone to be monetary manipulation.
I would further argue, though, that the growth of our unfunded liabilities is a form of liquidity and many estimate our unfunded liabilities for benefits like Social Security and Medicare to exceed $200 trillion. I am not including these in this calculation because the growth of these liabilities has occurred over several decades. But the fact is, we are incurring debt for something now that we are failing to pay for, which is a form of liquidity. It is what I refer to as “borrowed prosperity.” When we do finally deal with these debts, we will hear a huge sucking sound as money must be extracted from our nation’s GDP, wealth and economy to pay off our accumulating bills. This is what I mean by gravitational pull. We have certainly added significantly to this tab over the last five years with such actions as cutting payroll taxes for Social Security. Anything that increases your current economic consumption while pushing off your cost of your consumption (increasing liabilities) should be considered liquidity. Student loans, underwater mortgages — these are all liabilities that sit on the other side of our nation’s ledger and we seem not to grasp that we cannot increase one side of the ledger indefinitely. While some of the liabilities have future benefits to at least somewhat counter-balance them, the liabilities will far exceed to benefit and will therefore be a heavy economic burden on future generations.
However, what I really want to address is what I consider more immediate forms of liquidity. The imbalance of trade, which has increased by nearly $1 trillion over the last five years, and our nation’s exponential growth of debt are examples of these more direct forms of liquidity. While free money (ZIRP) is a form of liquidity (likely the greatest artificial stimulus), for the purpose of this exercise I cannot put a figure on it so I’m leaving it out of the equation. Over the last five years our national debt has grown from about $9 trillion to more than $16 trillion, so let’s round down to $7 trillion. Add to these two items to the increase in the Fed’s balance sheet of $2 trillion and you have a total of $10 trillion of “debt liquidity” added to our economy over the last five years, or about $2 trillion per year. Remember, we are talking “T” here (trillions)! What is the effect of $2 trillion dollars (not counting ZIRP) being added to our economy annually?
What is this number as a percentage of Gross Domestic Product (GDP)? I’m glad you asked that question. Our nation’s annual GDP is about $14 trillion — which I would argue is also inflated because of the Fed’s past stimulus policies, but we have to start somewhere. So the debt liquidity/money printing/not counting ZIRP is 14 percent of our annual GDP. That is a lot of manipulation. But what I found more interesting — I started to say astounding, but didn’t want to sound too dramatic — is our new liquidity as a percentage of our nation’s total wealth. Today our nation’s total wealth stands at about $54 trillion. This equates to 4.4 percent of new wealth being created out of thin air EVERY YEAR! If you look at the five-year liquidity total of $10 trillion, it equates to more than 18 percent of our nation’s total wealth. That is the definition of debasing our currency! And this is what I mean when I refer to our current hyper-liquidity experiment. How do you assess what is real in an economy that has been manipulated more than any time in our known history?
Now if all this liquidity and stimulus was being somewhat equally distributed, while still a questionable policy, at least it wouldn’t seem patently unfair. But the real reason for Main Street doing so poorly while Wall Street is back on top is because the vast majority of that $10 trillion flooded into our system in the last five years has landed in the financial markets. This is a very narrowly practiced supply-side economics. This is my hypothesis for explaining why all financial assets are rising while the number of Americans on food stamps has doubled.
As Druckenmiller said in the previous post, and I paraphrase, “I don’t know when or exactly how this all ends, but it will end badly.”