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The Coming Non-Linear World

by John Rubino on November 7, 2010 · 17 comments

With the election over, there’s no political rationale for the Fed printing another $600 billion. So what they’re seeing must be terrifying enough to make another round of quantitative easing seem like the least dangerous alternative.

They’re  wrong, says Prudent Bear’s Doug Noland in his latest Credit Bubble Bulletin:

It seems again worth highlighting a couple key sentences from ECB President Jean-Claude Trichet’s July 22, 2010 op-ed piece in the Financial Times, “Stimulate no more – it is now time for all to tighten”:  “…Given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors.”

The Bernanke Fed is playing with fire here.  QE1 was implemented in an environment of deleveraging, impaired global financial systems and acute economic contraction.  And, importantly, the dollar was enjoying strong performance in the marketplace as global risk markets suffered from de-risking and general outflows.  QE1 had a stabilizing influence, as it worked to accommodate financial sector de-leveraging.

The QE2 backdrop is altogether different.  Global markets are these days demonstrating robust inflationary biases.  Risk-embracement is back in vogue – speculation is rife.  The “emerging economies” and global risk markets have been on the receiving end of massive financial (“hot money”) flows.  Meanwhile, the dollar has been under heavy selling pressure with heightened risk of a crisis of confidence.  This week’s market activity supported my view that the environment would seem to dictate that QE2 will only exacerbate increasingly unwieldy financial flows and unstable global markets.

What does “non-linear” mean when applied to financial markets? It means we’re approaching a point when the future doesn’t emerge logically and consistently from the immediate past. Instead of asset prices and interest rates moving by typical modest increments, they’ll gap one way or the other. Circuit breakers might close the stock market while some commodities open lock limit up without even trading. Big banks or industrial companies will fail without warning because their derivatives have blown up, while companies in hot industries go public and double on their first day of trading. Some currencies will plunge while others soar, leading disadvantaged countries to impose capital controls and tariffs. And so on — with the US at the center of the storm.

In a non-linear world, rational planning becomes impossible because no one knows where lightning will strike next.  And the inflation/deflation debate loses its meaning, says Noland:

In post-announcement analysis of the Fed’s commitment to another $600bn of Treasury purchases, Bill Gross commented on CNBC that “the biggest risk is inflation down the road.”  I again disagree with Mr. Gross.  The greatest risk is a destabilizing crisis of confidence for our nation’s debt obligations.  Our system doubled total mortgage debt in just over six years during the mortgage/Wall Street finance Bubble.  Washington is now on track to double the federal debt load in just over 4 years.  Federal Reserve policy remains instrumental in accommodating a precarious Credit Bubble at the heart of our monetary system.

 

  • Bruce C.

    A credit bubble, which is what we have now, implies that there are far more claims to underlying real wealth than actually exists. The bubble starts to implode when some of those claims become severely devalued or worthless. That is what has been happening in many areas, RE foreclosures and loan write-offs due to defaults and bankruptcies being some obvious examples. The Fed has more insight into the financial status of the big banks than any one else and they see that credit destruction as evidence of possible full-blown market-wide deflation. Extend and pretend is still going on and that is what QE II is about. Viewed more cynically, it’s providing time for the insiders to take out whatever real wealth still exists before letting the SHTF.

    Remember, the Fed is not a part of the US government and it does not necessarily care about the dollar or US citizens are anything else except for its own power and wealth. It is a cartel of the biggest banks in the world.

    As far as “non-linearity” is concerned, I think the derivatives market will be the source of a lot of that. Recall how the original Greek credit crisis started. It was on April 19th that word got out that Greece MIGHT have trouble meeting its May 1 interest payments. Then all of a sudden, “sovereign debt” became household words. Why? Because that would have technically constituted default and would have triggered a land mine of derivative contracts. Think about it, in a more normal environment being late on a few interest payments would not have been such a big deal. As it was, word markets were moved mightily. A puny little country like Greece (1% of Euroland GDP) could not normally do that.

  • Franky

    What Bruce C. is a tyrin’ to say, ya’ll. Is do ya got guns?
    N’ philsophically speaking, what good are guns unless ya
    got a whole room full of bullets? The theoretical implications
    are staggering.

  • http://chaosandconspiracy.wordpress.com CompassionateFascist

    Insightful piece. When the Crash comes, it’ll be terminal w/in minutes – almost literally at the speed of light, this in turn partly thanks to tech like HFT and the Internet. As to when, I’d say the Fed monitizing the stock market is the final bubble…when it pops, everything goes. As to why – Black Swan excluded – the more they print, the more they have to print. At some not too distant point, 0 = 0.

  • http://www.billhopen.com bill hopen

    I think, or rather, I accuse the fed of a secret agenda inflation target of 20%/yr. Jolt the homebuyer to run and buy up excess housing as an inflation hedge/ close the books on RE mess/clear the market pay off all the debt in fluffy inflato-bucks. Jolt the saver to buy that car or what ever before it goes up…”keep that money moving folks, spend when you get it, borrow it and pay it back with cheaper bucks later, keep it moving- keep working- jump on the tredmill”
    Jolt the export market of US with cheaper goods to world markets eagerly buying at any price to get shed of US bucks before they devalue further. 20% per year, if two years or three years don’t do it …keep going.

    I accuse the fed of planning 100 billion a month QE forever as a perma put on treasuries….buy em all back from the world, good excuse to print print print and pay the vig on our debt by printing….tough! we say. When its all over our ft knox 8000 tons of gold = 2 or 3 cents backing on our 12 trillion dollars currently in M3 which may be double that 24 trillion after four years of printing….it’ll still be a penny of gold behind each dollar (at present gold price) it will be quite enough for a gold backed currency…who knows what gold valuation will be by then anyway. Any old siver dollar will buy $200 of todays groceries

  • Brad Thrasher

    Print? You neocons & tea baggers do indulge quaint old world notions. Move your watch forward 100 years. Money is digitized now. It’s a ledger entry. Moving at the speed of light.

    QE2 is an admission that QE1 didn’t work. As many said, QE1 wasn’t enough and it was misapplied. While money moves at the speed of light it moves within a closed circuit.

    In other words, remember that new buzz word, de-leveraging, we all learned? Well it’s still going on. The cost estimate for this round of de-leveaging is $600bn.

    With all due respect to Mr. Noland, QE is the central bank estimate of a given round de-leveraging. There is no doubt, no argument that QE has closed the gaps.

    While I quite agree with Mr. Noland’s metaphor of a non-linear economy, the fact remains that we’ve been in a non-linear since August 2007 when the subprime mortgage market bubble burst.

    For those of you who advocate in broad sweeping generalities such as credit bubble sky is falling end times, you offer nothing more than theoretical speculation.

    If you want to give some credibility to your advocacy identify the next gap, the next bubble, the next Greece.

    • AZDUCKMAN

      @Brad Thrasher: “tea baggers”, wow that’s witty! Did you just think of that? So, let me see, average working people who take to the streets to protest because they think it’s a bad idea to give the big banks and Wall Street banksters billions of tax dollars to cover their bad bets are, in your opinion, worthy of derision. It seems like I’ve read something about a country or two running into trouble by spending too much. But I guess those tea partiers are stupid because the smart people running our government know that “this time is different” and everything will be OK.

      With respect to your “printing” money comment, thank you so much for pointing out that it is done electronically now. I’m sure that most people reading this were like me and didn’t even realize that it’s done electronically. Again, thanks for the enlightenment.

  • Jonathan

    Anyone … what about the effects of dollar collapse on the rest of the currencies? Is it curtains for all currencies within minutes? Please explain .. thanks

  • Bad Dog

    Brad, Doug Noland has been diagnosing financial in the fragilty in the world economy for the decade I have been reading his stuff. His analysis has always been jaw-droppingly accurate. The bubble has moved to government finance because goverments absorbed the massive risk from bank balance sheets. When companies get in trouble, their stock gets hammered. When countries do, their debt gets pounded via rising risk premiums on their sovereign debt. If they try to create money to pay their obligations, their currency gets pounded. In a world where so many countries are trying to “print” (just a metaphor for money creation) their way out, they all go down together against commodities.

    Deleveraging isn’t the problem, it is the solution to an overly indebted and misaligned economy. QE just drags it out and makes it worse. It changes the shape of the implosion, but not the fact of it. It designates winners and losers, but much more is lost than gained across the entire spectrum of economic activity. QE 1..X can never bring recovery, just paper over a festering wound.

  • PeteCA

    John … no need for deep thinking here. Your 1’st sentence actually nailed the issue:

    “What they’re seeing [in the near future] must be terrifying enough to make QE seem like the least dangerous alternative.”

    Bingo.

    PeteCA

  • Concern

    QEII like QEI will not succeed as the money will just sustain the economy after which the economy will deteriote again. Money need to flow to productive areas and for US there are not any huge industries to flow to anymore. In the 80s, there is de-regulation, 90s the tech boom and 2000s the housing boom. The money will fund the buying of foreign goods, bonds and commodity markets. All of them non productive and highly inflationary.

  • Brad Thrasher

    @concerned, QE is working as evidenced by nearly a year of consistent job expansion in the private sector.

    @Bad Dog, Your self contradictions notwithstanding, my point is I no longer agree with the end times Mad Max scenario envisioned by Mr. Noland and others. All evidence indicates that QE is doing exactly Bernanke said it would do back in March 2009. It is, in stage one of QE, re-inflating the economy.

    Frankly, if the Dow had moved from 6500 to over 11,000 during a Republican Administration as it has under this Democrat Administration, you folks would be dancing on rooftops and looking around for another war.

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  • http://DollarCollapse Olyun

    We all (or almost all) of us, play the role of ants at a picnic. The best we can do is hope for a crumb to fall from the table and hope we don’t get stepped on or seen taking it away. It is not a “bad” way to look at life, but rather a realistic way. No matter what we as individuals think, or say, or even do, the result in our society is still the same. No one (those in the upper echelons of life) sitting at the picnic table even thinks about the ants unless they try to get into the food. Ask yourself this, “What happens to the ants if they are seen near the food at a picnic?” That friends is how little regard the general public is given.

  • Jason Emery

    Obviously, the dollar cannot devalue versus the other major fiat currencies without wrecking their economies, and therefore ours. And we can’t devalue versus the Chinese at all, with the currency peg in place. The only way out is to devalue versus gold.

    Since the federal debt, state debt, pension underfunding, unfunded liabilities of the federal govt., etc. are in the hundreds of trillions of dollars, a four figure gold price will soon be a barbarous relic, to correctly use ‘gold’ and ‘barbarous relic’ in the same sentence correctly.

  • Ed

    Brad: do you honestly think China won’t take action to counter the Fed’s dollar devaluation? You think they will just sit and take the abuse in fear of their actions eroding their investment in dollars further? Let me give you a hint: Paul Krugman is an idiot. China will take action that will make this 600 Billion look like we forgot one of the zeroes. Whatever you thought the amount should have been, you’d be wrong. The curve approaches infinity without ever reaching equilibrium. How could a Pulitzer winner have failed linear algebra? You have to “electronically” create money forever. Inflation is here, simultaneously with deflation. Inflation of commodities and deflation of assets spoken for by too many. Do a little more homework on derivatives. The risk is staggering. You cannot create enough money to cover numbers that large. As far as your challenge goes, Spain, Portugal, Ireland, Italy, France, and the Baltic States will all be having riots before too long. And then things get really nasty.

  • DavidN

    The money system is broken, period. For money to have value you have to be able to buy goods and services with it. If too much free money is created and given away store shelves will only hold what no one wants or what can be made locally under duress. Why work for worthless paper?

    We don’t need to jump start any economy. The always inflating economy is actually the problem. You can’t grow forever. Eventually you run out of land, oil, minerals and food. What the world needs now is a stable economy and lowered expectations. Your children will not be able to sustain the orgy of consumption that the last generation did. The Arab proverb that ends ‘my grandson will ride a camel’ will come true whether you like it or not.

    The whole world is in danger of becoming another collapsing USSR. Socialism only works until there is no one left to tax to pay for it. There is no one left now. There is no nice way out of this.

    You all better learn quick how to live off the land like an army on the move in enemy territory.

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