by Paul Craig Roberts, Paul Craig Roberts:
In Part 1, I explained that the next financial crisis will be bailed out not with central bank money creation but with our stocks, bonds and bank balances.
In Part 2, I explained the multi-year quiet regulatory changes that dispossessed us of our property.
In Part 3, I explain David Rogers Webb’s conclusion that a massive financial crisis is pending in which our financial assets are the collateral underwriting the derivative and financial bubble and will result in the loss of our assets but leave us with our debts as happened to those whose banks failed in the 1930s.
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Webb begins with the economic formula that the velocity of circulation of money times the money supply equals nominal Gross Domestic Product. V x MS = GDP.
The velocity of circulation is a measure of how many times a dollar is spent during a given period of time, e.g., quarterly, annually. A high velocity means people quickly spend the money that comes into their hands. A low velocity means people tend to hold on to money.
Velocity impacts the Federal Reserve’s ability to manage economic growth with money supply changes. If the velocity of money is falling, an expansionist monetary policy will not result in rising GDP. In such a situation, the Federal Reserve is said to be “pushing on a string.” Instead of pushing up GDP, money supply increases push up the values of financial assets and real estate resulting in financial and real estate bubbles.
Webb notes that falls in velocity are precursors of financial crises. A multi-year sharp fall in velocity preceded the stock market crash in 1929 and the Great Depression that gave birth to regulatory agencies. The 21st century is characterized by a long-term fall in velocity that has reached the lowest level on record, while stocks and real estate have been driven to unprecedented levels by years of zero interest rates. When this bubble pops, we will be dispossessed.
Will the bubble pop?
Yes. The Fed suddenly and rapidly moved from zero to 5% interest rates, a reversal of the policy that drove up prices of stocks and bonds. The Fed raises rates by reducing money supply growth, thus removing the factor supporting high stock prices and collapsing the value of bonds. This results in a lowering of the value of stocks and bonds serving as collateral for loans, which, of course, means the loans and the financial institution behind them are in trouble. Bonds have already taken a hit. The stock market is holding because participants believe the Fed is about to reverse its interest rate policy and lower rates.
Webb notes that the official data show that the velocity of money collapsed in the 21st century while the Fed introduced “quantitative easing.” He makes the correct point that when the velocity of money collapses, the Fed is pushing on a string. Instead of money creation fueling economic growth, it produces asset bubbles in real estate and financial instruments, which is what we have at the present time.
When after more than a decade of near zero interest rates, the Fed raises interest rates it collapses the values of financial portfolios and real estate and produces a financial crisis.
As the authorities have set in place a system that bails out secured creditors with our bank deposits, stocks, and bonds, we will have no money and no financial assets to sell for money. People with mortgaged homes and businesses will lose them, as they did in the 1930s, when they lost their money due to bank failures. People with car payments will lose their transportation. The way the system works is you lose your money but not your debts.
The secured creditors are the creditors of the troubled institutions. Ultimately, the secured creditors are the mega-banks defined as “privileged creditors.”
The collapse of financial asset values in 1929 resulted in the failure of 9,000 banks (https://www.encyclopedia.com/economics/encyclopedias-almanacs-transcripts-and-maps/banking-panics-1930-1933). Bank failure meant that you lost the money you had in the bank. It means the same thing today regardless of deposit insurance, because your deposits have been turned into collateral for creditors. Moreover, FDIC deposit insurance is a joke. The FDIC’s assets are in the billions. Bank deposits are in the trillions. The Dodd-Frank Act prioritized derivatives over bank depositors, so a bank account holder is in line behind derivative claims. Apparently, FDIC insurance claims will be issued in the form of issuance of stock in a failed bank.
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