The ECB Takes Keynesianism to the Limits via Negative Deposit rates

I find it quite ridiculous for the mainstream to claim that the Eurozone has been experiencing a ‘recovery’ when the financial-banking industry continues to push the European Central Bank (ECB) to further ease.

Apparently, as previously noted, recent record setting stock markets in developed economies has largely been in anticipation of the ECB and Mario Draghi’s accommodation to such pressures.

Today the ECB obliged.

From Bloomberg:

The European Central Bank cut its deposit rate below zero and said it would announce further measures later today as policy makers try to counter the prospect of deflation in the world’s second-largest economy.

ECB President Mario Draghi reduced the deposit rate to minus 0.10 percent from zero, making the institution the world’s first major central bank to use a negative rate.

Notice that central banks have all been pushing monetary policies—from intensifying use of QE, ZIRP and now Negative Interest Rates—to the limits.

They have waged an all out war against savings via the abolishment of interest rates as advocated by the high priest of inflationism, John Maynard Keynes (bold mine)

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

In short, the euthanasia of the rentier lowers interest rate with the aim that no one will find savings profitable such that everyone will simply spend. Mario Draghi and the ECB would make JM Keynes proud.

Yet this is really a camouflage for perpetual debt accumulation.

Aside from Negative Deposit Rates, the ECB has placed in the pipeline more on easing measures. From the Zero Hedge (bold original)

The much anticipated additional measures have been revealed:

-DRAGHI UNVEILS PACKAGE OF TARGETED LTROS, WORK TO PREPARE QE

-DRAGHI SAYS INITIAL SIZE OF TARGETED LTRO PLAN IS 400BLN EUROS

-ECB EXTENDS FIXED RATE FULL ALLOTMENT, SUSPENDS SMP STERILIZING

-DRAGHI SAYS PACKAGE INCLUDES PREPARATIONS FOR ABS PURCHASES

In other words, even more actions along what was expected: keep in mind the last time the ECB did €1 trillion in LTROs it did exactly nothing to boost inflation or the "real economy." Furthermore, the ABS purchases aren't activated: just being "prepared." However, what was not revealed was the biggest wildcard: European QE, which as we said repeatedly, won't happen until Europe's deflation is far worse, if ever.

All these represent no more than subsidies, as I previously commented: 

governments around the world have been forcing a 'reverse Robin Hood' redistribution of plundering the Main Street in favor of the Wall Streets of the world through a variety of financial repression policies such as blowing bubbles, bank deposit haircut, negative deposit rates and more…  

Yet there is no such thing as a free lunch. Every action has a consequence. Unproductive spending and malinvestments will backfire. As the great Austrian economist Ludwig von Mises presciently warned (bold mine)

The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether. All present-day governments are fanatically committed to an easy money policy. As has been mentioned already, the British Government has asserted that credit expansion has performed "the miracle...of turning a stone into bread." A Chairman of the Federal Reserve Bank of New York has declared that "final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity." Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as illintentioned advocates of the selfish interests of usurers.

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

It is sad to see that that the average citizens of the world have been treated like guinea pigs by monetary authorities, for an age old experiment that not only transfers resources from society to the the political class and their cronies but importantly has been DESTINED for failure: quasi booms morph into horrific busts.

When real savings have been substantially diminished relative to misallocated capital, then expect and prepare for a global economic depression in a not so distant future.

Quote of the Day: Negative Deposit Rates Represents Savings Confiscation

“Negative deposit rates” means that the banks will charge the customer for saving money and placing it in the bank.  According to Keynesian theory (if there really is such a thing) government needs to spur “aggregate demand” in order to stimulate the economy to increased production.  Keynes had no respect for savings…only spending.  He called the consequences of savings to be a “paradox of thrift” in that if we all save instead of spend, then the economy will go into a death spiral.  He was completely ignorant of capital theory, which explains that REAL capital, not paper money capital, comes from deferring spending ON CONSUMER GOODS in order to increase spending ON CAPITAL GOODS.  The money that we save is not destroyed.  It goes into the lendable funds market to finance long term capital investment that will pay future dividends, both literally and figuratively, ensuring MORE goods in the future.

It is a mark of the fanaticism and desperation of the Keynesians that they would resort to threats of money confiscation in order to prevent people from saving and force them to spend in the present.  This is shear and utter madness…some might say it is theft on a vast scale, perpetrated by government fanatics

(all caps original)

 

This is from Professor Patrick Barron at the Mises Canada responding to the ECB’s proposal to impose negative deposit rates. The above tersely dispels the myth of the alleged virtues of spending over savings which bubble worshipers promote.

And as one would note, governments around the world have been forcing a 'reverse Robin Hood' redistribution of plundering the Main Street in favor of the Wall Streets of the world through a variety of financial repression policies such as blowing bubbles, bank deposit haircut, negative deposit rates and more…  

Quote of the Day: Nobody is More Generous than the Miser

In this whole world, there is nobody more generous than the miser—the man who could deplete the world’s resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide.

If you build a house and refuse to buy a house, the rest of the world is one house richer. If you earn a dollar and refuse to spend a dollar, the rest of the world is one dollar richer—because you produced a dollar’s worth of goods and didn’t consume them.

Who exactly gets those goods? That depends on how you save. Put a dollar in the bank and you’ll bid down the interest rate by just enough so someone somewhere can afford an extra dollar’s worth of vacation or home improvement. Put a dollar in your mattress and (by effectively reducing the money supply) you’ll drive down prices by just enough so someone somewhere can have an extra dollar’s worth of coffee with his dinner. Scrooge, no doubt a canny investor, lent his money at interest. His less conventional namesake Scrooge McDuck filled a vault with dollar bills to roll around in. No matter. Ebenezer Scrooge lowered interest rates. Scrooge McDuck lowered prices. Each Scrooge enriched his neighbors as much as any Lord Mayor who invited the town in for a Christmas meal.

Saving is philanthropy, and—because this is both the Christmas season and the season of tax reform—it’s worth mentioning that the tax system should recognize as much. If there’s a tax deduction for charitable giving, there should be a tax deduction for saving. What you earn and don’t spend is your contribution to the world, and it’s equally a contribution whether you give it away or squirrel it away.

 This is from author and University of Rochester economics professor Steven Landsburg on the virtue of savings.

Quote of the Day: Spending Isn’t Production

If we take a step back and think about it, it’s obvious that spending per se isn’t the source of economic benefits. It’s easy to spend. If that were really the only thing holding back economies in recession, then one wonders why humans still suffer from recessions, in so many countries and so repeatedly throughout history.

No, the real difficulty in economic life is production, in turning scarce resources into goods and services that the consumers value. This takes judgment on the part of entrepreneurs directing the process, and it takes hard work from their employees.

In addition to inventions as well as commercial innovations in business operations, a major source of economic growth is saving and investment. Even with a fixed amount of technological know-how, people can gradually increase their standard of living over the years if they defer immediate gratification. By saving out of present income—by living below their means—people “free up” scarce resources that no longer need to be used up to make burgers, iPods, and sports cars. Instead, these resources can be redirected into making tractors, drill presses, and microscopes for drug researchers. Rather than making consumer goods for present wants, the economy cranks out capital goods to cater to future wants. This is the physical analog of how the economy as a whole grows, just as an individual household’s bank balance grows with constant saving.

It should be clear that spending per se doesn’t drive economic growth. It’s true, in a modern economy money plays a crucial role in coordinating our activities, and in that sense spending is an integral part of the story. But from this truism it hardly follows that government spending is all we need right now to “boost the economy.” On the contrary, government spending simply siphons real resources away from the private sector and into politically-chosen channels, where they will be used in inefficient ways.

(bold emphasis mine)

This is from Professor Robert P. Murphy at the American Conservative

Sovereign Debt The New Ponzi Finance?

``I have no sympathy for Madoff. But the fact is his alleged Ponzi scheme was only slightly more outrageous than the 'legal' scheme that Wall Street was running, fueled by cheap credit, low standards and high greed. What do you call giving a worker who makes only $14,000 a year a nothing-down and nothing-to-pay-for-two-years mortgage to buy a $750,000 home, and then bundling that mortgage with 100 others into bonds, which Moody's or Standard & Poor's rate AAA, and then selling them to banks and pension funds the world over? That is what our financial industry was doing. If that isn't a pyramid scheme, what is?" Thomas Friedman, The Great Unraveling

As we have earlier exhorted, navigating the rough waters of 2009 markets will be challenging. It is because conventional analysis would have to be sidelined in exchange for the reading of political actions into the pricing system of the marketplace. The traditional scrutiny of earnings and GDP growth will have to pave way for the fundamentally altering risk reward environment motions of political preferences and the unforeseen reactions that such directives may engender.

As PIMCO’s Mohamed El-Erian recently wrote, ``Where does this leave investors? As my colleague Paul McCulley likes to say, only a thin line separates courage from stupidity. Investors should position their portfolios predominantly under the umbrella of government support rather than outside it; they should follow government actions rather than pre-empt them; and they should focus primarily on the senior parts of the capital structure.”

For starters, we understand that governments around the world will jointly be conducting monetary and fiscal programs to arrest the destructive impact of debt deflation and its aftermath. For instance in terms of fiscal measures, some of the reported expenditures earmarked for stimulus programs are (IIF.com): Japan $105 billion or 2% of GDP, European Union $254 billion (1.5% of GDP), Australia $7.4 billion (1% of GDP), China $586 billion (8.9% of GDP), India $4 billion (1.5% of GDP), South Korea $11.3 billion (1.1% of GDP), Chile $2 billion or (1.5% of GDP) and Mexico $5.8 bullion (.8% of GDP). Overall an estimated $3 trillion could be sourced from the markets this year three times that of 2008 (Financial Times).

Yet despite these immense allocations from the fiscal side, yield spreads in benchmark sovereigns of most OECD economies have been dramatically falling to reflect a “flight to safety” (see figure 1).

Figure 1: IIF.com: 10 Year Bonds

And this is not just reflected in nominal yields but likewise in real yields (or inflation adjusted). This means that based on market price signals from today’s bond market, interest rates of major economies are expected to remain low despite the proposed surge of issuance of government bank debt instruments.

To consider, bond yields play a very significant role in the economy as they signify ``an important transmission mechanism through which an easing in monetary policy affects the broader economy” to quote the Institute of International Finance (IIF), the world’s only global association of international financial institutions with some 375 members in 70 countries. Big segments of consumer credit are being benchmarked to these instruments. As the IIF further points out, `As low rates permeate down the yield curve, so they help support activity affected by longer-term rates”. For example, the US mortgage market used to be highly correlated or had been benchmarked from the 10 year bond yields until the emergence of this crisis.

While it is true that today’s bond market “flight to safety” boom favors government’s activities of providing cheaply funded fiscal programs, it is unlikely that the prevailing conditions could be sustained over the long term. As a caveat since we are not in the business of market timing, booms can last until it can’t.

Why? As we have previously stated, the fundamental problem is one of debt overload. Most of the major economies have absorbed far too much debt more than it can afford to sustain. And the subsequent debt deflation preceding the inflationary boom comes with the feedback loop dynamics of regressing and shriveling collateral values, funding or liquidity constraints and a paucity of capital.

With over $30 trillion of stock market capitalization vaporized in 2008, additional enormous losses in other markets (see 2008 Trivia: Lobby, Bailouts and Losses) and most importantly, losses in the financial institutions have now tallied over $1 trillion see figure 2.

Figure 2: IIF: Losses and Capital Raised

According to IIF (bold highlight mine), ``Reported and potential losses have put pressure on bank capital, despite the fact that banks and other financial institutions have raised $930 billion of capital, more than a third of which represents government’s stakes. As a defensive response, banks have conserved their capital and liquidity to be in a position to absorb potential losses, thus reinforcing counterparty risk aversion in drying up interbank transactions. Investors have also pushed banks to raise their capital, not only as measured by their Tier 1 ratio but also the equity/asset ratio. Essentially, until asset markets settle down so that investors can form a clear assessment of potential losses, more capital injection including by governments will not be sufficient to stabilize the banking system.”

As noted by IIF, the mounting losses in asset values as reflected in the financial system losses will likely impel the industry to remain on the defensive by trying to remediate balance sheet impairments than to provide “normalized” business activities or rekindling risk activities. This essentially relegates the burden of providing support of collateral asset values, liquidity constraints and capital provision to the government which ironically depends on taxpayers, or borrowing capacity or the printing press. As clearly manifested in figure 2, the US government have substantially been replacing the private sector as purveyors of such capital.

Yet, in a recessionary environment, which technically means decreasing economic output but factually translates to the market clearing of malinvestments caused by previous inflationary policies, surviving private businesses will likely be safeguarding assets and also be conservative or scrimp on expansion plans while households will likely exercise austerity. Thus, the ability to save should essentially reflect the ability to refinance or reinvest.

But governments aren’t interested about savings. In fact governments are afraid of savings or the so-called misguided popular Keynesian concept of the “paradox of savings” or “paradox of thrift”. What is good for the individual is extrapolated to be bad for the economy, as we discussed in Consumer Deflation: The New Fashion. A weakening economy is always projected on the prism of the slackening of demand which necessitates government’s role to assimilate on such shortcomings. Thus, governments everywhere expect to takeover the role of “inflating” their national economy billed to the taxpayers of the next generation. It is a concept which relies on the principle of SOMETHING for NOTHING based on the virtue of consumption over production. (Why do you think central banks are adopting Zero Interest Rate-ZIRP regimes?)

Proof? From the incoming President Obama [CNNMoney], ``What's required for the economy right now [is] to put more money into the pockets of ordinary Americans who are more insecure about their jobs, who are continuing to see rising costs in an area like health care, who are struggling to make ends meet." Where does one source funding “to put money into the pockets of the masses”?

But if history should serve as guide, the performance of a command driven economy almost always underperforms and produces more dependence on inflationary actions which exacerbates the entire vicious process of inflation-deflation (boom-bust), market-socialism cycles.

As Ludwig von Mises presciently wrote (bold emphasis mine), ``“The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.”

This is unfortunately true today. As for our politicians and their lackeys, this addiction to spend using taxpayer’s resources, which is construed as an inexhaustible pool, is unsustainable. But like the recent real estate boom bust conditions, unsustainable [boom] trends can’t last, as the popular Herb Stein quote goes, ``If something cannot go on forever it will stop.”

Predicated on the surge of government rescue programs, the IIF views the onrush of government issuance and today’s market pricing as brewing pressure of destabilizing imbalances (bold highlight mine), `` It is hard to reconcile this bond market pricing with economic policies (both monetary and fiscal) designed to stimulate recovery. The inference, of course, is that G10 bond markets have become distorted by extreme conditions under which end investors and financial institutions are desperate for the apparent security offered by government bonds. As a result something of a bubble has developed in these debt markets. The problem with this flight to “quality”, however, is that G10 government bond yields are thus liable to upward correction at some point, either because of credit or inflation concerns (or a bit of both). This implies considerable downside price risk, which could be a new source of financial sector volatility at some point in the future.”

Nonetheless, the basic problem lies squarely with the patent building up of the mismatches between the supply side-availability and accessibility of capital-with the government’s demand for it.

Hence, if global economies recover and risk appetite regains ample groundswell then the safehaven pricing for treasuries will severely be reversed, as money flows will be redirected towards risk assets.

On the other hand, if the leverage absorbed and produced by the governments can’t be sustained or paid for by the revenues generated by the economy or its lack of ability to pay gets reinforced, then the sovereign risks of a credit default could become a reality.

This reminds us of Mr. William Gross’ outlook who recently discoursed about some of the intrinsic Ponzi structures in the US economy, `` Municipalities with begging bowls now extended for over a trillion of Federal taxpayer dollars, based their budgets and their own handouts on the perpetual rise in home prices, the inevitable upward slope of sales taxes, and the never-ending increase in employment and personal income taxes. To add injury to insult, they conveniently “balanced” their books with a host of accounting tricks that Bernie Madoff could never have come up with in his wildest imagination. Now, with cash flow insufficient to meet current outflows, they are proving my point that we have met Mr. Ponzi and he is us – all of us: auto companies that siphoned sales dollars to make labor peace instead of research and design expenditures; hedge funds that preposterously billed investors for 2% and 20% of nothing; a President and politicians who thought they could fight a phony war for free and distract the nation’s attention from $40 trillion of future social security and health care liabilities. Ponzi, Ponzi, Ponzi.”

Yes, sovereign debt has now assumed the new role of Hyman Minsky’s Ponzi financing.

Fundamentals of Credit Default Risks

So the credit default risks from sovereign debt emanates primarily from the debt issuance far outnumbering the pool of available capital, especially in a world where external trade has been shrinking and collateral has been losing value.

Another, any signs of the reemergence of inflation or of a global economic recovery may result to a stampede out of a one sided trade.

Furthermore, government debt will be competing with the private sector debt on a global scale for funding or capital raising, which is likely to lead to a “crowding out” effect. The crowding out effect as defined by wikipedia.org is ``when the government expands its borrowing to finance increased expenditure, or cuts taxes (i.e. is engaged in deficit spending), crowding out private sector investment by way of higher interest rates.”

Of course, the “crowding out” phenomenon will only happen once the mechanism of the present global flow of funds diminishes. (We don’t believe that it will reverse because under a US dollar standard system, deficits are the inherent characteristic of the currency reserve economy.) Yet such phenomenon will likely occur as a result of governments working to strengthen their domestic economies, by utilizing their savings and or forex surpluses at home than by undertaking the previous global “vendor financing scheme”.

The crowding out effect, which gives priority to domestic government consumption than to private investment, therefore stifles economic growth. Therefore a world which engages in “nationalist” oriented policies would likely see repressed economic growth.

In addition, if the US Federal Reserve makes good of its threats to close the arbitrage gaps along the yield curve of US treasuries, by manipulating (buying) the long end, which is meant to reduce the incentives for the US banks to hold reserves and compel them to normalize operations (as we discussed in 2009: The Year of Surprises?), then such actions could possibly function as a window for the forex surplus rich major trading partners to “gracefully” exit US treasuries, while at the same time massively expand the balance sheet of the US Federal Reserve (possibly beyond the capacity for its citizenry to finance) and or serve as the bubble “blow-off” which could reintroduce substantial volatility back into the financial markets.

Remember, any drastic upsurge in the interest rates, as indicated by the activities in the US treasuries, will only serve to undo any incremental gains accrued from the recent activities.

Moreover, given the ginormous leverage built into the financial system, a sudden increase in US interest rates will mean higher cost of financing for the US government or for those institutions and virtually the economy on a lifeline which could further undermine its economic recovery path.

As we have earlier said, 2009 could likely be an exciting year, simply because government policy actions risks creating an environment where financial and economic conditions could swing from one extreme end to the other.

Consumer Deflation: The New Fashion

``All the major institutions in the world trying to deleverage. And we want them to deleverage, but they’re trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that’s willing to leverage up. And there’s no one that can leverage up except the United States government.-Warren Buffett, Interview Transcript

This world is full of befuddling ironies.

Just last year, when consumer prices were rampaging skywards, we were told by media and their experts how “inflation” was bad for the economy. Today, as consumer prices has been falling, the same forces of wisdom explain to us how “deflation” has likewise been detrimental to the economy or perhaps even worst….

As example we are told that declining consumer prices “aren’t just symptom of economic weakness” but are “destructive in and of themselves”. Why? Because as demand weakens and prices decline, companies cut employment and investment, slowing economic growth even further. Thus the chain of inference includes “falling earnings, a weak economy, and the hoarding of cash, fewer investors are willing to buy stocks during deflationary times.”

And the “deflation” theme has grabbed the headlines see figure 1.

Figure 1: Economist: The Deflation Index

According to the Economist, ``Back in August, only six stories in the Wall Street Journal, International Herald Tribune and the Times mentioned “deflation”. In November, there have already been 50, and new figures released this week will mean many more. America's consumer-price index fell by 1% in October from September as oil prices plunged, the largest monthly fall since the series began in 1947. Britain's inflation rate has also fallen from its record high of 5.2% in September to 4.5% in October, the biggest drop in 16 years.

For starters, falling prices basically reflect demand supply imbalance, where supply is greater than demand. Such conditions may be further prompted by either supply growing FASTER than demand or demand declining FASTER than supply.

Paradox of Savings And Growth Deflation

When prices fall because of technological innovation such as the mobile phones, the internet and others, these items become affordable and have rapidly been suffused into the society enough to make it an economic staple.

For instance, mobile phones are expected to hit an astounding 61% global penetration level according to the UN (Europe News) or about 6 out of 10 people will have access or be using mobile phones by this year. According to high profile economist Jeffrey Sachs, the diffusion of mobile communications will revolutionize logistics and education that should benefit the rural economy.

Quoting Mr. Sachs, ``The mobile revolution is creating a logistics revolution in farm-to-retail marketing. Farmers and food retailers can connect directly through mobile phones and distribution hubs, enabling farmers to sell their crops at higher “farm-gate” prices and without delay, while buyers can move those crops to markets with minimum spoilage and lower prices for final consumers.

``The strengthening of the value chain not only raises farmers’ incomes, but also empowers crop diversification and farm upgrading more generally. Similarly, world-leading software firms are bringing information technology jobs, including business process outsourcing, right into the villages through digital networks.

``Education will be similarly transformed. Throughout the world, schools at all levels will go global, joining together in worldwide digital education networks. Children in the US will learn about Africa, China, and India not only from books and videos, but also through direct links across classrooms in different parts of the world. Students will share ideas through live chats, shared curricula, joint projects, and videos, photos, and text sent over the digital network.” (underscore mine)

Moreover, falling prices should translate to more purchasing power.

So how can falling prices be all that bad?

The answer lies squarely on the Keynesian dogma of the “Paradox of Savings”. What supposedly signifies as virtue for individuals is allegedly (and curiously) a bane for the society. The idea is that when people save or withhold consumption, the underlying consequence would be a reduction in investments, employment, wages, etc. etc, thereby leading to a slowdown or even a contraction of economic growth. Seen from the aggregate top-down framework, less consumption equals less economic growth.

This has been profusely peddled by media and the social liberal school as basis for justifying GOVERNMENT INTERVENTION to conduct policies aimed at stimulating growth or rescue, bailout or other inflationary policies to avoid “demand contraction”.

Anecdotally, if savings is truly so bad for an economy then Japan should be an economic basket case by now, yet it holds some $15 trillion in household assets as of June, of which only 13.9% is in stocks and mutual fund and $7 trillion in bank deposits. This in contrast to the US where only 17% is in deposits and 50% is into stocks and pension funds (Washington Post). Japan’s high savings rate has even been reflected in public sentiment where a polled majority refuses to accept government offers to “stimulate” the economy (see Free Lunch Isn’t For Everyone, Ask Japan), as it had learned from its boom-bust cycle experience.

From the Austrian school perspective, the Japanese scenario can be construed as a “Cash Building Deflation” case. From Mises.org’s Austrian Taxation of Deflation by Joseph Salerno, ``Despite the reduction in total dollar income, however, the deflationary process caused by cash building is also benign and productive of greater economic welfare. It is initiated by the voluntary and utility-enhancing choices of some money holders to refrain from exchanging titles to their money assets on the market in the same quantities as they had previously. However, with the supply of dollars fixed, the only way in which this increased demand to hold money can be satisfied is for each dollar to become more valuable, so that the total purchasing power represented by the existing supply of money increases. This is precisely what price deflation accomplishes: an increase in aggregate monetary wealth or the “real” supply of money in order to satisfy those who desire additional cash balances.”

In addition, this Keynesian obsession with “aggregate demand” says economic growth should be associated with “inflation”.

Figure 2: American Institute For Economic Research: Falling US Dollar

Yet, if inflation is measured by means of the increase or loss of a currency’s purchasing power, then the US dollar’s appalling loss of purchasing power since the birth of the Federal Reserve in 1913 (see figure 2) shows that US economic growth hasn’t been primarily driven by productivity (productive economy=an environment of falling prices or “deflation” as more goods or services are introduced) but by inflationary policies or by money and credit expansion!

Note: the chart also exhibits that when the US dollar had been redeemable into monetary commodities (gold or silver), purchasing power of the US dollar tends to increase. Yes, this is defined as DEFLATIONARY ECONOMIC GROWTH or GROWTH DEFLATION (!)

Again from Mises.org’s Austrian Taxation of Deflation by Joseph Salerno, ``In fact, historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard.” (highlight mine)

Falling Markets: Debt Deflation Not Consumer Price Deflation

But savings isn’t about the absolute withholding of consumption. There is a very significant time dimension difference: it is a choice between spending and consuming today or in the future. Moreover, there are two types of consumption to reckon with; non productive consumption and productive consumption.

The definition of savings according to the Austrian School, excerpting Gerard Jackson, (underscore mine)``The full definition is that savings is a process by which present goods are transformed into future goods, i.e., capital goods, that produce a greater flow of consumer goods at some further point in time. In short, present goods in the form of money are used to direct resources from consumption (the production of consumer goods) into the production of capital goods.”

When we put cash balances into a bank, the bank functioning as intermediary parlays such deposits into loans (for business or for consumers) or as investments in securities (private e.g. corporate bonds or public-local government e.g. municipal bonds or national government e.g. Treasuries). So essentially, our savings are channeled into the private sector or as financing to government expenditures.

Thus, the paradox of savings or the anticipated rise of savings rate in the US or in countries severely impacted by the deflating mortagage backed credit bubble, given the magnitude of government efforts to “cushion” or “rescue” the financial system and the economy, will effectively be utilized to finance most of these government programmes.

The negative aspect is not that the consumption ripple effect will result to lower economic growth but instead savings channeled into public/government consumption effectively crowds out private investments which should lead to LOWER productivity and thereby lower economic growth prospects.

Furthermore, when media discusses about consumption, it focuses on the consumers which accounts as the non-productive aspect of consumption.

A productive consumption is where one consumes in order to be able to produce goods. A baker who consumes food in order to bake is an example of productive consumption.

And non-productive consumption, as defined by Dr. Frank Shostak, is ``when money is created "out of thin air." Such money gives rise to consumption, which is not backed by any production. It leads to an exchange of nothing for something.”

In short, the recent boom in consumer spending hasn’t been on the account of spending for production but representative of an explosion of “nothing for something” dynamics or where a policy induced free money environment impelled the US populace to go into a massive speculative orgy, thereby giving the illusion of wealth from producing nothing and limitless nonproductive consumer spending. Of course many of these nothing for something dynamics has also spilled over to many developed countries.

Likewise, the recent account of falling prices or economic weakness hasn’t been a direct cause of retrenching consumers but as an offshoot to a reversal in the free money landscape and a bursting bubble. Thus the apparent economic weakness from a slackening of consumer spending signifies as symptom and not the cause.

Put differently, what makes falling prices or what media or the Keynesian perception of pernicious deflation is nothing more than DEBT DEFLATION!

Once more from Joseph Salerno’s Austrian Taxation of Deflation [p.13-14], ``The most familiar is a decline in the supply of money that results from a collapse or contraction of fractional-reserve banks that are called upon by their depositors en masse to redeem their notes and demand deposits in cash during financial crises. Before World War Two bank runs generally were associated with the onset of recessions and were mainly responsible for the deflation that almost always characterized these recessions. What is called “bank credit deflation” typically came about when depositors lost confidence that banks were able to continue redeeming the titles—represented by bank notes, checking and savings deposit —to the property they had entrusted to the banks for safekeeping and which the banks were contractually obliged to redeem upon demand…

``During financial crises, bank runs caused many banks to fail completely and their notes and deposits to be revealed for what they essentially were: worthless titles to nonexistent property. In the case of other banks, the threat that their depositors would demand cash payment en bloc was sufficient reason to induce them to reduce their lending operations and build up their ratio of reserves to note and deposit liabilities in order to stave off failure. These two factors together resulted in a large contraction of the money supply and, given a constant demand for money, a concomitant increase in the value of money.”

As you can see Salerno’s description of a Debt Deflation landscape as “depositors lost confidence that banks were able to continue redeeming the titles”, “revealed for what they essentially were: worthless titles to nonexistent property”, “threat that their depositors would demand cash payment en bloc”, and “a large contraction of the money supply and, given a constant demand for money, a concomitant increase in the value of money” have been all consistent and cogent with today’s evolving activities in the banking system, the global financial markets or the real economy.

As we have pointed out in many past articles as the Demystifying the US Dollar’s Vitality or It’s a Banking Meltdown More Than A Stock Market Collapse!, the collapse in the US mortgage market which accounted for as a major source of collateral for an alphabet soup of highly geared structured finance (e.g. ABS, MBS, CMBS, CMO, CDO, CBO, and CLO) instruments which likewise underpinned the $10 trillion shadow banking system, resulted to a near cardiac arrest in the US banking system last October, where banks refused to lend to each other reflecting symptoms of an institutional bank run (see Has The Global Banking Stress Been a Manifestation of Declining Confidence In The Paper Money System?).

The sudden surge or “increase in the value of money” in terms of the US dollar against the an almost entire swathe global currencies (except the Japanese Yen) reflected its role as international currency reserve where its dysfunctional banking system incited a systematic “hoarding” of the US dollar, the unwinding of the US dollar carry trade or almost a near contraction of money supply (until the US government’s swift response see The US Mortgage Crisis Taxpayer Tab: $4.28 TRILLION and counting…).

Similarly such dislocations have been transmitted via synchronous selling and an astounding surge in volatility across global financial markets and an intense disruption in the $14 trillion trade finance market, all of which has combined to impact the global real economy.

The present selloffs in the global equity markets as reflected by the activities in the US markets have reached milestone levels see Figure 3.

Figure 3: chartoftheday.com: US Stock Market Corrections

The meltdown in the US markets have been on short, in terms of duration, but whose magnitude has been more than the average of the typical bear market losses.

Why should it be that a selldown be remarkably drastic if it were to account for only a consumer recession? The answer is it isn’t.

Thus, the so-called destructiveness isn’t about US consumers retrenching but an intense deleveraging process backed by the heuristic reflexivity concept of a self-feeding loop of falling prices=falling demand and vice versa.

Eventually false premises tend to be corrected.