Continuing Deflation in the "Real Economy"

Financiers have the world’s financial system in a “doom loop,” says the Bank of England. We’ve thought so ourselves. The bankers take money from the government and use it to speculate, not to lend. “Excess” reserves are at a record high as consumer credit continues to decline.

Most people find it both galling and absurd to see the bankers getting $10 million bonuses while there is 10% unemployment. Here at The Daily Reckoning, it’s just a matter of curiosity. You’d think there would be more wage competition to drive down bankers’ compensation. Why doesn’t Goldman go to an unemployment line and make an offer…

“Any of you guys want to earn a $9 million bonus?”

Surely there would be a few takers. And Goldman would save $1 million.

Of course, we’re joking. Banking is not a trade you can pick up just like that. Borrowing from the Fed at 1%…lending back to the Treasury at 4%…hey, it must take a few days of training to be able to turn around money like that.

On the other hand, there are periods when speculating for a big bank is a breeze. Over the last 7 months, for example, there was almost no way fed-financed traders could lose money. They borrowed dollars – the new carry-trade funding currency – at next to zero interest. It didn’t matter what they did with it…they could trade it for Brazilian reals…or buy stocks in Singapore…or buy gold. Almost everything went up against the dollar.

Institutional investors – such as those managing money for banks – are judged on how well they do against the benchmarks, the averages, not on how much money they make or how many losses they avoid. If their colleagues are making money, they have no choice. They have to get in the game too.

So, they’re in a “doom loop,” where they continue to bid up asset prices – even at the beginning of a depression.

Meanwhile, over in the real economy…the deflation continues. David Rosenberg:

“It is like a magic show – the US economy is somehow out of recession with both employment and consumer credit outstanding still in full-fledged contraction mode.

“In September, total consumer credit fell $14.8bln making it the eighth month in a row of debt repayment – an unprecedented string of declines. Over this period, the amount of consumer credit (not including mortgages) that has come out of the system has totaled $163bln at an annual rate (or -6.3% at an annual rate). Looking at the fact that total household debt still exceeds long-turn norms of 60% by a factor of more than two, we are still in the early stages of a secular credit contraction that could well end up seeing another $5 trillion of debt collapse. This is a highly deflationary process; it will take time; and while we are bullish on gold and commodities strictly on global supply-demand imbalances, bonds remain a very good place because deflationary episodes provide solid real yields to investors.”

Let’s see. We’ve tried several ways to gauge how long it will take to de-leverage the private sector (which is another way of figuring how long this depression will last). At 6% a year – assuming private sector has about 2 times as much debt as it should have – it will take about 7 years to get down to a more comfortable level?

Did we do the math right? Well, who knows? But every time we do it, we come up with about the same answer – 7 to 10 years, more or less.

But it’s not that simple. Because as the private sector de-leverages the feds try to prevent it…while they leverage up the public sector. This is bound to stretch the whole thing out…and bound to lead to some serious bust-ups.