U.S. Monetary Transmission System Remains Broken

One would think that Buffett would be a bit more circumspect when his holdings have benefited so wildly from the fraudfest of the last few years:

The “gusher of federal money” has rescued the financial system and the U.S. economy is now on a slow path to recovery, Buffett wrote in a New York Times commentary yesterday. While he applauds measures adopted by the Federal Reserve and officials from the Bush and Obama administrations, Buffett says the U.S. is fiscally in “uncharted territory.”

The "gusher" has done no such thing.

As I have repeatedly pointed out (including in the Tickers of the last two days) the transmission mechanism in our monetary system - the "moneyness" of debt transmission and sale - remains broken.

It remains broken because we have refused to prosecute and remove those who have committed fraud from the system, we have refused to force honest marks to be taken on these so-called "assets", and we have refused to clear the system of the bad debt.

We have instead "gushered" newly-issued Federal Debt into the system.

This is similar to someone presenting in the emergency room with a severed femoral artery. By continually injecting huge amounts of blood you can prevent circulatory collapse and the death of the patient.

However, your ability to continue this path of "treatment" is limited by your supply of blood. If you do not repair the severed femoral artery before you run out of blood supply the patient will die.

We have done nothing about the severed femoral artery.

The government is trying to spark business and consumer spending through a $787 billion stimulus plan spanning tax cuts and infrastructure projects, while the Treasury and the Fed have spent billions more on separate programs to rescue financial institutions and resuscitate the banking system. The U.S. budget deficit is forecast to reach a record $1.841 trillion in the year that ends Sept. 30.

There's the draining of the blood bank. How much longer can we continue to draw on what our policy-makers seem to think is an unending credit supply of accumulated reserves in China and Japan?

This much is certain: There is a finite supply, just as no matter how many pints are in storage in the local hospital, there is a number on that store, and it can and will run dry if it is tapped at a rate that exceeds its replenishment rate.

Officials must still do “whatever it takes” to get the U.S. economy back on its growth momentum, Buffett wrote.

"Whatever it takes" means locking up the fraudsters and eliminating the practice and capacity to lie about asset valuations. Trust in the private credit markets must be restored; this is distinct from allowing these institutions to lie and then backstopping the explosions that would otherwise result.

The former sews shut the femoral artery, the latter is simply injecting another pint of blood.

“Once recovery is gained, however, Congress must end the rise in the debt-to-GDP ratio and keep our growth in obligations in line with our growth in resources,” Buffett said. “With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

Recovery cannot be gained until the fraud stops. This is axiomatic: while you can continue to pump water out of a leaking boat and it will continue to float so long as the rate of water being pumped out of the bilge exceeds the rate of flooding, the fact remains that until you plug the hole the ship remains in peril and if, for any reason, the bilge pump fails (say, it runs out of gas!) you're going to sink.

“Unchecked greenback emissions will certainly cause the purchasing power of currency to melt,” Buffett said. “The dollar’s destiny lies with Congress.”

No Warren.

The economy's destiny lies with law enforcement. Congress has already made unlawful all manner of fraud, and intentionally overstating the value of alleged assets qualifies under the definition of fraud.

We cannot have a durable economic recovery until the credit transmission mechanism returns to normal function. And that, as Warren is fully-aware (along with Bernanke), cannot happen so long as we have firms that are lying about asset valuations.

Buffet's Berkshire has been the beneficiary of these backstops and in addition many of the businesses that Berkshire are engaged in are massive exposed to these frauds, if not engaged in or complicit in them themselves.

It is time for Buffett to renounce his inner pigman and come clean: Fraud must be flushed from the system, the insolvent institutions must be closed, the bad assets must be cleared from the balance sheets and insoluble debt must be defaulted if we are to have a durable and strong economic recovery.

We tried to avoid recognition of the overhang (and resolving it) in 2000-03. We "succeeded" only in creating a bigger mess, just as we did after 1987, and the impact of each bubble's "reflation" attempt has come with a greater and greater cost in the intermediate term, yet the impact of each dollar of debt in terms of GDP sponsorship has continued to slip.

The mathematics of credit-based monetary systems make the outcome of an attempted "reflation" without clearing the bad debt from the system inevitable - you can "buy" short-term relief (as we have) but with each "reflation" you get less benefit, less relief, and a greater and greater hangover.

We are now at the point where the literal stability of our financial and political systems are at issue - the formerly-applied "solution paths" no longer lead to positive outcomes to any material degree as we are critically close to the point (if we have not exceeded it!) where a new dollar of debt actually produces negative GDP change.

Once that tipping point is reached collapse is assured as no new debt creation can succeed and in fact you must force dramatic and immediate contraction in outstanding debt in order to stave off a complete collapse of the monetary system involved.

We must not go there, irrespective of the crooning of those who are desperately trying to save themselves on a sinking ship - especially when the crooners were themselves involved in drilling the holes that put the ship in peril in the first place!

Comments

[Donald Ingram:]

Karl - Well written. Good metaphor with the boat.
Yes. The 'rule of law' must be put back on the tracks and enforced to restore confidence. During the S&L crises indictments were issued and prosecutions were pursued, with the result that the fraudsters went to jail.
This present crises makes the S&L affair look like a tea party in comparison! So how many indictments have been issued? How many prosecutions have been pursued? How many fraudsters headed to jail?
The 'rule of law' has been ignored. Those guilty have thumbed their noses at it. Especially the Federal Government when it came to contract law and it's handling of the GM bond holders!
There is no confidence in the present system or administration.

Aug 19 11:40 AM

[markfl:]

You may be aware that a recent study www.foxnews.com/politi.../ from the Kansas City FRB suggested we may easily have unemployment above 8 percent through 2011--perhaps beyond.

Drawing on the experience of political rhetoric from the last two recessions, I am convinced this high unemployment rate will be used to justify continued deficits and, perhaps, unjustifiably low Fed accommodation on the grounds that the economy is "too weak." They will use this pretext even if GDP growth remains positive. The usual chorus refrain is that the budget can't be constrained and interest rates can't be tightened because conditions are "too fragile." This was the justification in 2002-2003.

There will never be a good time to reduce spending. Even when it became clear that the immediate emergency post-9/11 had abated and the economy was improving, there was always an excuse. In fairness, I don't absolve Clinton's first term or Gingrich's congress from blame either. The American public simply has no appetite for the pain. Even in Reagan's first term, we were never successful in killing off even one cabinet agency. I'm not sure we ever will be.

Aug 19 11:55 AM

[Ray Lopez:]

tinyurl.com/pdljc9

raylopez99.blogspot.com/

Click on the first link for a graphic that shows discussion over TARP was the cause-in-fact of the equities crash of October 2008. This link is from the second link above.

A picture is worth a thousand words.

RL

Aug 19 01:16 PM

[Andrew Butter:]

As always spot on.

Out of the $17 trillion of toxic debt that was created from 2000 to 2007 "dumb foreigners" bought half, during that time the Treasury sold about $4.5 trillion of bonds, of which foreigners bought 40%. That's the scale.

So the theory is that all those dumb foreigners after getting ripped of for the sum of $1 trillion to $2 trillion are going to be lining up around the street to get shafted again?

The :gush" of money that Buffet refers to, all $2.7 trillion is not getting lent, it's just sitting in the banks propping up their balance sheets.

Did you see Dr. William Black's video? Apparently ratings agencies often gave ratings without even reviewing the tapes. That's simply criminal negligence.

After the S&L they locked up 1,000 fraudsters, this is ten times bigger, they need to lock up 10,000.

So guess how much of the $700 billion is being deployed hiring extra investigators and prosecuters?

Exactly zero.

Go figure who is in charge, the bandits took over Dodge.

Aug 19 01:48 PM

[The Hammer:]

Buffett is fine with piling on all the bills on future generations. Ron paul is one of only a few public figures that is telling the truth of the dangers we face. where are all the arrests between the realhores, appraisors builders mtg brokers wall street mbs scum,ws traders, bank executives, sub-prime executives.
There should be thousands of arrest for this corruption and malfeasance!

Aug 19 03:03 PM

[BlackyBlack:]

Sometimes I think it all collapsed long ago and you guys are just arguing about the facades finally falling over. The script to this movie even seems plagiarized. Is there a real economy there somewhere? To use the blood transfusion analogy - how long has the patient been on the table and how long have we known that he was dead but kept pumping anyway? I'm beginning to think a lot of waste in the system is for the purpose of this artificial pump - keep pumping money out and a lot of it will be wasted - but what sticks will be enough to give us positive inflation er gdp I mean.

Aug 19 06:49 PM

[LIVE FREE O...:]

As always Karl, great article.

Warren Buffet has made quite a lot of money and probably is a really nice guy butttt over the past several years his comments have been less then helpful.

For example, he is fully aware that many of these bank executives, attorneys, politicians, regulators, etc. are all hip deap in this swamp of conflict of interest, contracts, unethical behavior, illegal activities, and other closely related actitivities. While this is going on he indicates are deficit is increasing. Thank you....lots of other bad things are happening as well Warren. Guys continue to lie, cheat & steal on Wall Street, and don't even get me going on what the politicians are trying to do to us.

But Warren has confused me a bit.

1st Example - I think it was last year (October maybe) when he said he was buying "America stock" and it came out months later that he had actually been dumping American stock, not buying. The market was in trouble and he was actually being less then honest with the financial community.

2nd Example - "Dirivatives are the equivalent to a nuclear bomb", said by Warren Buffet. 1 or 2 years later we find out Warren is hip deap in dirivatives and had the losses to show for it.

I like Warren Buffet. Warren is a very wealthy man. But I think he has taken some really silly and unnecessary credibility hits over the past couple of years. I don't know who his advisor is but it ain't work'n

If anyone is "in the no" it would be Warren. Warren needs to be quite or just retire. Warrens comments start to become just a bit embarrassing.

Aug 19 11:35 PM

[HunterGVL:]

Good Article - I agree with the sentiment and have even sent a letter (I just know I am making a difference??) to the white house asking that the Attorney General start indicting the CEOs of rating agencies, the CEOs of the worst of the derivative speculators and sellers, and the congressmen and women suffering from massive conflict of interest offenses.

Might as well have just spit into the wind. Two things I worry about the most? First - We are about to suffer an incredible decline in economic worth, and many citizens will lose their retirement funds and all and any remaining equity in real estate, suffering through years of stagnant growth. Second - We do not suffer a decline right now, but rather through the machinations of greedy and corrupt politicians and stupid policies, we reinflate the greatest and final bubble of all time and a few years hence, our entire financial system collapses and all of us lose.

If there is to be no accountability by those who have brought about this economic catastrophe, then the second scenario above will likely be the result.

I am not a gold bug per say although I do have a 5% security blanket with the shiny stuff. However, if this market is not allowed to fall and the DOW roars back towards 14K and beyond, then I will begin buying bullion at every pullback until we reach the final conclusion to this speculative abomination -Complete Financial Collapse.

Maybe in some dank and dimly lit basement where the Goldman Sachs prophets plan and concoct market moves for us all, complete financial collapse is just, 'the next thing.'

Aug 20 09:43 AM

[TeresaE:]

Nicely done again.

My only addition is when you state, "..We cannot have a durable economic recovery until the credit transmission mechanism returns to normal function. And that, as Warren is fully-aware (along with Bernanke), cannot happen so long as we have firms that are lying about asset valuation..."

Reality is that we cannot have durable economic recovery until we level the playing field with China and Mexico and bring back family supporting (thus business supporting) jobs from the third world.

Liars loans and bad debt to equity ratios are what signaled the end of the run, I don't see how "credit" will pull us back out.

"...We cannot have a durable economic recovery until the credit transmission mechanism returns to normal function. And that, as Warren is fully-aware (along with Bernanke), cannot happen so long as we have firms that are lying about asset valuation..."

Aug 20 10:00 AM

[basehitz:]

Buffett said:
“Once recovery is gained, however, Congress must end the rise in the debt-to-GDP ratio and keep our growth in obligations in line with our growth in resources,”

The ONLY time in our history we were anywhere close to this far in debt, FIRST we had to unwind the excessive leverage before sustainable growth.
2.bp.blogspot.com/_vIR...

It seems common wisdom today is to use the playbook from previous recoveries of our lifetimes. My contention is we are now in a situation that does not fit that model. . . . unless of course the govt intends to endless print money. In that case, you might get stocks to rise but it will trash the currency.

Aug 20 03:01 PM