The Fed's phony boom is becoming a real bust

Guest post by Bill Bonner, Editor, The Bill Bonner Letter

Editor's Note: All along, we’ve known the Federal Reserve's actions to "goose" the economy would cause a financial disaster. Although these actions created a “fake” recovery from the 2008 financial crisis, they’ve set us up for an even worse collapse today, says Bill Bonner in this guest post. Right now, it's all starting to fall apart - and this bust is just getting started...

[Bill originally wrote this essay on January 18, 2016, in Bill Bonner’s Diary.]

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The Fed's Phony Boom Is Becoming a Real Bust
by Bill Bonner

The average stock in the S&P 1500—which includes about 90% of all stocks listed in the U.S.—is now down more than 15% from its June 2015 high. The standard definition of a bear market is a sustained fall of 20% or more from recent highs.

"Woeful earnings," suggested MarketWatch as a cause.

Another guess: "The stock market is freaking out over Trump and Sanders."

Barron's was closer to the real source of the plunge: "Without Fed's Juice, Market Suffers Withdrawal Pains."

In 1971, phony fiat money replaced the old gold-backed dollar...and money that came "out of nothing" replaced real savings.

At first, inflation rates rose. No one trusted the new fiat dollar. But then, incoming Fed chairman Paul Volcker showed the world that the U.S. could manage its currency in a responsible way.

Consumer-price inflation fell, along with interest rates. Debt increased. And gradually, every Middlesex village and farm became dependent on more and more bank credit. Bank credit, not real savings, is what generates prosperity said the mandarins.

Instead, bubbles just kept bursting: the dot-com bubble blew up in 2000. The mortgage finance bubble blew up in 2007.

Now, it looks as though another bubble is deflating...

Booze Binge

In 2008, the Fed cut rates all the way down to the "zero bound" to try to keep the jig going.

But after seven years of its emergency zero-interest-rate policy (ZIRP), it became obvious that something had to be done to get back to "normal."

Like a long binge on booze and drugs, things were starting to get a little weird.

The juice had to go.

But we doubt that the syringes and the Johnnie Walker have been put away for long. Despite announcing a great improvement in employment, for example, there have never been so many American men without jobs.

Retail sales are falling. The transport industry—ships, trucks, rails—is in a funk. And the energy sector is in crisis...with as much as one-third of the sector's debt headed for default.

What's the matter?

The simple answer is that credit is not expanding fast enough. Lenders have become wary. Rolling over short-term financing is getting harder and harder to do.

Yields on supposedly "risk-free" Treasury bonds are going down (and prices are going up). Yields on junk bonds are going up (and prices are going down).

"Any time credit fails to increase by at least 2% a year," said credit analyst Richard Duncan at Macro Watch, "the economy shrinks."

From Boom to Bust

And what's happening now? How fast is credit increasing?

Uh-oh...

It's not increasing at all. It's falling...for the first time since 2009.

Not only is the juice no longer going into the system, it is actually going out.

Which is just what you'd expect. The phony boom created and funded with the Fed's phony money (counterfeit capital that is simply borrowed into existence) is now turning into a real bust.

China's foreign exchange reserves are falling. The ships sit idle in their ports. Orders for new trucks, new rail cars, new tankers, and yellow machines of all sorts are hitting record lows.

The whole kit and caboodle creaks and groans to a halt.

And now, Bloomberg asks: "Is it over?"

At least that question is easy to answer. No, it's not over. It has hardly even begun.

Regards,

Bill