paulbissett.com

I am going to put the summary upfront – Ben Bernanke, the Federal Reserve, the Treasury, Congress, and the President are all making a bet. They’re betting that they can stuff enough money in the financial system to forestall a total financial and economic market meltdown. To a large extent, they seem to have succeeded. But is it enough?

The short answer is probably yes. The money released and committed will cover the expected reductions in available capital when compared to the Great Depression. The longer answer (not covered here) is that the devil will be in the details of how the money gets put into the hands of those that can create jobs, income, and wealth.

My biggest concern is that re-regulation of the financial (and other industrial) markets combined with large government deficits may reduce the efficiency of this money that has been stuffed into our financial systems. This would cause the money to flow into higher prices (inflation) rather than job and wealth creation. An easy money policy combined with a highly regulated business environment is a recipe for stagflation.

Now for the numbers – The total government monetary action in this financial crisis is approaching $13 trillion. This does not include the deficit spending by the administration, but just the amount of money that has been made committed by the Federal Reserve, FDIC, and Treasury. This amount of money is nearly equal to GDP. Is there a reason for so much cash?

Perhaps. Let’s take a look at some debt statistics from today and the Great Depression.

Figure 1

Figure 1 shows Total Debt from the period of 1929 to 1940. At the beginning of that financial crisis, Total Debt to GDP started at 170% and climbed to 270% by 1932. This rise in the ratio was caused mainly by the drop in GDP by 57%, as Total Debt had not climbed but rather had fallen by 9% (Figure 2).

Figure 2

Figure 3 shows the growth in total US debt from 1975 to 2008 in relation to GDP . The Total Debt (Public and Private) to GDP ratio climbed from 160% to 370% during this period. Remarkably this was during a period of dramatic GDP growth, and thus represents a true growth in the amount of debt used to fuel Total GDP growth. In short, there has been a real growth in the use of leverage over this period.

Figure 3

So what does this say about current easy money period? It is a well-known fact that Ben Bernanke is a student of the Great Depression period and is determined not to exacerbate the current problems with a tight money policy. A look at Figure 2 shows that the greatest decrease in relative debt was in the Private Money, Individual category. Within that category the greatest percentage decrease was in Commercial and Security Margin debt. A tight money policy during this period caused a negative feedback into economic growth that helped accelerated job loss and wealth destruction. Interestingly the percentage fall in GDP matched the fall in this Debt category during the period 1929-1932.

Total Debt between 1929 and 1934 fell 13%. A similar fall from the 2008 Total Debt of $52.6 trillion would remove $6.9 trillion from the economy. It could be said that the government has replaced over $4.2 trillion of the expected loss of financing, and is committed to another nearly $8 trillion, if needed. This should seem to be sufficient to keep the economy from a suffering the crippling loss of capital seen during that Great Depression period.

One difference is that the 2008 Financial Debt appears to be a much higher fraction of Total Debt during this period than the previous period at 33% versus 11%. A similar fall of 60% of this type of Debt would remove $10 trillion from the Total Debt. The current total commitment of $13 trillion would appear to cover this worse case scenario in the reduction of available capital.

What does this all mean? Well, it means that the Fed has stepped up to backstop the loss of credit that might occur in a financial crisis. And it does look like they have provided enough when compared to the Great Depression period.

The only thing now will be whether the money flows through the system to those who require the credit. The actual money flows into the economy will be controlled by re-regulation of financial markets, congressional legislative agendas, and government fiscal policy. The financial fire appears to be out, let the rebuilding phase begin.