Anatomy of a credit crunch induced bankruptcy - Eric Janszen

[metalman]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

When a loan defaults, the bank doesn't just throw up their hands and say "oh, well!" The defaulted loan must (eventually) be written-off against bank profits. Bank profits are also reserves (they are not credit money). So the result of a default is the destruction of reserves -- which is worse (in a deflationary sense) than the destruction of credit money that results when a loan is paid off, because it can impair the bank's future ability to lend. With enough defaults, a bank will fall below its reserve requirements, and will be closed by the FDIC, or forced to merge with another bank that can shore-up its reserves.

This is one of the reasons the Fed has been flooding the system with new reserves -- it's an attempt to offset the losses from defaults.

thank you! that is very clear.

still, that does not 'destroy' money but does impair the bank's ability to issue new loans and create new money.

[grapejelly]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

When a loan defaults, the bank doesn't just throw up their hands and say "oh, well!" The defaulted loan must (eventually) be written-off against bank profits. Bank profits are also reserves (they are not credit money). So the result of a default is the destruction of reserves -- which is worse (in a deflationary sense) than the destruction of credit money that results when a loan is paid off, because it can impair the bank's future ability to lend. With enough defaults, a bank will fall below its reserve requirements, and will be closed by the FDIC, or forced to merge with another bank that can shore-up its reserves.

This is one of the reasons the Fed has been flooding the system with new reserves -- it's an attempt to offset the losses from defaults.

You are over complicating matters. If the loan defaults, the bank has a writeoff. But only the future ability to make loans is impaired. Even if the bank is closed down, every dime of money that was borrowed into existence by outside borrowers was presumably spent in the economy. The money isn't being returned, so there is no money deflation.

No money is removed from the economic system. It is removed, however, upon repayment.

Repayment of loans is deflationary, just as creation of the loans was inflationary.

[Sharky]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

No it isn't destroyed. Only when money is PAID BACK is it destroyed. Which isn't a bad thing, but anyways...defaults do not result in money being destroyed. Completely different.

Only PAYING BACK LOANS removes money from the money supply. Defaults do not remove ANY MONEY from the money supply.

When a loan defaults, the bank doesn't just throw up their hands and say "oh, well!" The defaulted loan must (eventually) be written-off against bank profits. Bank profits are also reserves (they are not credit money). So the result of a default is the destruction of reserves -- which is worse (in a deflationary sense) than the destruction of credit money that results when a loan is paid off, because it can impair the bank's future ability to lend. With enough defaults, a bank will fall below its reserve requirements, and will be closed by the FDIC, or forced to merge with another bank that can shore-up its reserves.

This is one of the reasons the Fed has been flooding the system with new reserves -- it's an attempt to offset the losses from defaults.

[santafe2]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

itulip ought to offer a primer on this fact. no one seems to get it. money is lent into existence... it can only be paid back out of existence.

the thing is to think of money as flows not as levels. a new loan adds to the amount of money flowing through the economy.

Chris Martenson's Crash Course has been posted on iTulip several times before but may be worth a repost. Chapter 7 is useful with regard to this issue.

http://www.chrismartenson.com/crashcourse

[metalman]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

No it isn't destroyed. Only when money is PAID BACK is it destroyed. Which isn't a bad thing, but anyways...defaults do not result in money being destroyed. Completely different.

Only PAYING BACK LOANS removes money from the money supply. Defaults do not remove ANY MONEY from the money supply.

itulip ought to offer a primer on this fact. no one seems to get it. money is lent into existence... it can only be paid back out of existence.

the thing is to think of money as flows not as levels. a new loan adds to the amount of money flowing through the economy.

[grapejelly]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

Another large source of deflationary forces would seem to me to be defaults on mortgages and other loans. Whenever a loan defaults (or gets paid back), the money behind it is destroyed.

No it isn't destroyed. Only when money is PAID BACK is it destroyed. Which isn't a bad thing, but anyways...defaults do not result in money being destroyed. Completely different.

Only PAYING BACK LOANS removes money from the money supply. Defaults do not remove ANY MONEY from the money supply.

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

Thanks Santafe!
Inflation is no bloody solution. It just causes more misallocation of scarce resources...particularly cash! Why does everyone think we are in this crisis?????
Due to FIRE ECONOMY resulting from inflation and negative interest rates, we have a gross misallocation of resources which has lead to the current collapse! So the solution is - we inflate even more grossly and deliberately... yeah right!

[metalman]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

Can I just clarify something. Is this your preferred measure of money supply and credit in the economy?

I follow (I think) the idea that inflation is an increase in the money supply and credit in the economy. This leads to increases in such measures of the decrease in purchasing power of each unit of money as the consumer price index.

My problem is, there are so many measures of money supply and credit that I am left rather bewildered.

one of our members wrote in once from argentina... said that with inflation in double digits there and interest rates at 20% for anyone with GOOD credit, never mind everyone else, most business is done in cash... ain't no credit there to speak of. wish that guy'd come back and clear up this confusion.

[Sharky]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

I am skeptical there are "no deflationary forces." What about the de-leveraging taking place for foreign entities paying back their loans to US banks that they took out during the credit bubble of recent? They buy dollars to pay back loans, causing the dollar to rise and making imports cheaper from an exchange perspective. That seems like a deflationary force.

I can't think of many more examples, if any, but I'm not sure that "no deflationary forces" is a true statement.

Another large source of deflationary forces would seem to me to be defaults on mortgages and other loans. Whenever a loan defaults (or gets paid back), the money behind it is destroyed.

As far as data goes, what about M3? Its rate of increase has dramatically declined over the last year. In fact, the recent turn up, combined with the extremely rapid increase in M1, could very well be indications of inflation's return in the near-term.

The flip-side of the argument is that loan defaults could easily be much higher this year than last, particularly with the upcoming prime and Alt-A resets.

[metalman]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

As you point out below, the US$ is mostly a Euro mirror, (almost 60%). I would just as soon predict where the Euro will be at the end of 2009 by flipping a coin. That said, I'll be surprised if the US$ retreats significantly from it's basket buddies.

You're saying the sea of currency values is evaporating. And, that the value of the US$ may be currently evaporating less fast than other currencies does not mean it's rising. EJ wrote something similar in his reference to $900 gold. Even more impressive when measured against the loonie where gold is at an all time high.

As I review the somewhat abstract notions above I have to compare it to my recent experience in the US. There is no price inflation, there is price deflation. It's everywhere. "Stuff" is not going up in price it's sitting on a shelf or parking lot. I understand the economic definition of deflation and the difference between that and the price of stuff deflation. But if the price of stuff keeps going down one can put all the money one can print back into our system and there will be so little velocity, we'll continue to see price deflation.

so far so good, forecast wise. worth a re-read...

Fed cuts dollar, Fire sales vs FIRE sales, Duh-flation, and Bezzle shrinks again

[santafe2]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

The need-to-have stuff, like food, rent, haircuts, and so forth isn't following that price deflation pattern. Whether that is entirely due to a depreciated relative currency, or something else, is unclear to me.

In the US "rent" has moved down in cost for many. For some, it's the walk-away and buy next door for 1/2 the cost. For others it's buying a house at 1/2 the cost it sold for in 2006 and securing a 5% mortgage. And still for others it's foreclosure and renting at 1/2 the cost or less.

You might be right about the haircut but I still get mine for $12 so I'm not complaining.

[GRG55]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

As you point out below, the US$ is mostly a Euro mirror, (almost 60%). I would just as soon predict where the Euro will be at the end of 2009 by flipping a coin. That said, I'll be surprised if the US$ retreats significantly from it's basket buddies.

You're saying the sea of currency values is evaporating. And, that the value of the US$ may be currently evaporating less fast than other currencies does not mean it's rising. EJ wrote something similar in his reference to $900 gold. Even more impressive when measured against the loonie where gold is at an all time high.

As I review the somewhat abstract notions above I have to compare it to my recent experience in the US. There is no price inflation, there is price deflation. It's everywhere. "Stuff" is not going up in price it's sitting on a shelf or parking lot. I understand the economic definition of deflation and the difference between that and the price of stuff deflation. But if the price of stuff keeps going down one can put all the money one can print back into our system and there will be so little velocity, we'll continue to see price deflation.

We [in Canada] have been seeing "price deflation" for "stuff" also [as I've noted in some posts on other threads]. And my wife has been taking advantage of that by stockpiling various appliances and other manufactures she intends to install in the bunker.

But I also note that, with the notable exception of petroleum energy, the price deflation here is restricted to the sort of stuff that sits on department and big-box store shelves; the sort of stuff that is nice-to-have. Slightly used toys like snowmobiles, ATVs, waterski boats, and other recreational discretionaries are still falling as truly distressed sellers drag everyone down the price curve.

The need-to-have stuff, like food, rent, haircuts, and so forth isn't following that price deflation pattern. Whether that is entirely due to a depreciated relative currency, or something else, is unclear to me.

[santafe2]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

When EJ first laid this out last year he was clear that it was impossible to predict the timing of the decline in US $, only that it was "when-not-if" and, at that time, iTulip's best guess was starting sometime in mid-2009 [iirc].

As you point out below, the US$ is mostly a Euro mirror, (almost 60%). I would just as soon predict where the Euro will be at the end of 2009 by flipping a coin. That said, I'll be surprised if the US$ retreats significantly from it's basket buddies.

I'm not sure it much matters what the US $ index does, given it's mostly an indicator of the $/Euro cross. The declines of the Euro and Pound [and Swissie] suggest a growing loss of confidence in those currencies...a path the US$ has already travelled. So a rising US $ index would not suggest to me some newfound improvement in confidence in the bonar.

I have no difficulty imagining an outcome where the US $ does relatively well compared to currencies that are equally abused by their respective Central Bankers, but do not enjoy reserve currency status [in a world where there exists no obvious replacement]. I also don't have any difficulty imagining every one, including the US $, continuing to lose real purchasing power.

You're saying the sea of currency values is evaporating. And, that the value of the US$ may be currently evaporating less fast than other currencies does not mean it's rising. EJ wrote something similar in his reference to $900 gold. Even more impressive when measured against the loonie where gold is at an all time high.

As I review the somewhat abstract notions above I have to compare it to my recent experience in the US. There is no price inflation, there is price deflation. It's everywhere. "Stuff" is not going up in price it's sitting on a shelf or parking lot. I understand the economic definition of deflation and the difference between that and the price of stuff deflation. But if the price of stuff keeps going down one can put all the money one can print back into our system and there will be so little velocity, we'll continue to see price deflation.

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

Agreed. Gold can easily be the least affected of all assets vs. the USD rise. Does not mean it's embarking on a blistering bull market rise vs. the USD though. It can of course continue to be a quite good investment in any number of other currencies though. The USD breaking up past 88 on the above index has another significance though, at least to this reader. The big first event was the USD breaking down through 80 on that index in mid 2007. That was a once in 25 years event and it broke to the downside very decisively. That probably gives the preliminary hint as to what will work out over the next decade (i.e. USD is most definitely headed down below that in a big way).

The huge anomaly however has been it's breaking right back up through that 80 level in 2008. After the USD's first blistering run up last year, it broke and had this violent decline, leading many to conclude it was a false breakout and that the smart money must remain positioned for an imminent USD collapse. The 80 level still lies below and it's a very big floor or ceiling, depending on which side of it the USD winds up on after these recent gyrations. So in relation to that, if the USD now runs up past 88 (the recent high) and so indicates it's heading on north from there, actually this is a very large indicator that it's break back up over 80 on the index was decisive, and it would at very least suggest that the intermediate run is going to be up rather than down.

Some people will pooh pooh this entire glance at that 80 USD index as "even meaning anything" but there are competent currency tacticians out there who insist that whichever side of 80 the USD accelerates away from gives the macro direction that's likely good for at least a couple of years if not more. In other words and in brief, what the USD is going to do now relative to it's recent high at 88 is actually quite telling. An "inevitably collapsing USD" is going to be a thesis under a bit of strain if we see the dollar move up past 88, and we could see how that particular juncture works out within just a month or two. And BTW, this is not technical chart navel gazing - it is merely watching what the USD is **actually doing**.

So what if the USD breaks 88-90. Does that automatically mean that gold declines? IMO, if the USD breaks 90, that means the Euro and the Pound are getting decimated, and Europeans will continue buying gold just like they have been recently.

There is no reason why both the USD and Gold cannot strengthen RELATIVE to other currencies.

[GRG55]

Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

Thanks Fred, I remember reading this article. Let me see if I can restate the iTulip position.

• Debt deflation will be a swift process and will be old news before the end of Q2.
• The US$ has been the beneficiary of this world wide deleveraging process, moving up in value relative to other currencies.
• The dollar will soon begin again to move down in value, (see attached chart for reference).
• The Fed/Treasury infusion of trillions of dollars into the economy will be the main force driving down the relative value of the US$.
• Inflation similar to the 1970s will follow.

[ATTACH]985[/ATTACH]

If this is a fair representation of the position, I don't disagree with the outline but I do question the time line with regard to the re-appearance of inflation. Inflation will be counter to everything the US government is trying to accomplish in 2009 to restart the economy. Should it reappear quickly, the consequences will be devastating.

A few examples of how high inflation will work at cross currents with our recovery plan:

• Home sales in the worst hit areas of the country have picked up significantly now that prices are roughly 50% the 2006 high. YOY sales in Las Vegas are up over 150%. One of the main reasons sales have picked up is that mortgage interest rates are at historic lows. If these rates move up 2,3,4%, sales will come to a halt and housing will again resume its decline.
• Auto dealers can't give a new car away. If the commodities that go into making a car and the borrowing costs both move up before the end of this year, we'll have no auto industry in the US.
• Higher unemployment will continue to be a problem in the US throughout 2009. Inflation will only serve to exacerbate and elongate unemployment and our general economic problems. The grocer will be competing against back yard gardens and home grown chickens. Overall caloric intake will shrink. For example, a head of lettuce may move up in cost but people will no longer buy washed and bagged lettuce leaves.

It will be difficult for inflation to take hold while the participants in the US economy continue to spend less money. Printing trillions of dollars will make inflation possible in the short run and probable further out, but that currency has to be paired with a reasonable velocity and I don't see how that will happen this year.

When EJ first laid this out last year he was clear that it was impossible to predict the timing of the decline in US $, only that it was "when-not-if" and, at that time, iTulip's best guess was starting sometime in mid-2009 [iirc].

I'm not sure it much matters what the US $ index does, given it's mostly an indicator of the $/Euro cross. The declines of the Euro and Pound [and Swissie] suggest a growing loss of confidence in those currencies...a path the US$ has already travelled. So a rising US $ index would not suggest to me some newfound improvement in confidence in the bonar.

I have no difficulty imagining an outcome where the US $ does relatively well compared to currencies that are equally abused by their respective Central Bankers, but do not enjoy reserve currency status [in a world where there exists no obvious replacement]. I also don't have any difficulty imagining every one, including the US $, continuing to lose real purchasing power.