Karl Denninger hits one out of the park

See my post below about the latest warning lights flashing over the Greek economy, then read what Karl Denninger had to say over the weekend about the warning lights in our own economy.  Here’s an excerpt.

The problem with the “recovery” is that it does not square with reality.  Net systemic leverage remains at double or more historical — and stable — levels.  It is that leverage that has “floated” the stock market (and housing market) higher, but this leverage is an outrageous fraud upon the public because it relies on the claim that one can continue it on a perpetual basis.

That leverage, however, came about only due to ever-decreasing borrowing costs.  Not low and stable borrowing costs, ever-decreasing ones.

Remember how this works:

You borrow $10,000 @ 10%.  Your coupon cost (annually) is $1,000 (interest.)

You never intend to pay back the principal when you initiate this cycle (note that the US Government has never actually reduced its indebtedness over the entirety of this 30 year period.)

Now the cost of borrowing goes to 8%.  You now can borrow $12,500 — another $2,500 in principal — and you do so and immediately spend it.

Then the cost of borrowing goes to 6%.  You can now borrow $16,667 and do so, adding another $4,166 in debt, and you spend that $4,166.

Then the cost of borrowing goes to 4%.  You can then borrow $25,000, $8,333 more, and you do so and spend it.

And finally the cost of borrowing goes to near where it is now, 2%, and you can borrow and spend another $25,000.

You started with $10,000 out in borrowing with a $1,000 interest cost.  You now have $50,000 outstanding with the same $1,000 interest cost, and that $40,000 gets spent, driving up the “price” of assets.

The fact is that this is exactly what has been done, and it is displayed right here:

I didn’t make this chart up.  It is taken from the Fed’s Z1 and BEA’s GDP tables — the canonical sources for data of this sort.  It shows that all economic “growth” over the last 30 years has been nothing more than spending money borrowed on increasingly-cheaper terms, not economic progress.  It has all been a lie.

But during that time period the value of those assets in real terms has not changed.  A 3-bedroom house still sleeps the same number of people, still contains the same number of toilets and still has the same kitchen in it that allows one to prepare the same number of meals.  Further, the premise that led to the increase in the price of the assets is that this cycle can be maintained forever, and this is a lie.  Trees do not grow to the sky and borrowing costs cannot continually decrease forever because nobody lends intentionally at a loss.  Lenders eventually conclude that’s exactly what they’re being asked to do as prices are rising faster than yields will cover, and thus you are losing money by letting someone borrow your capital at those rates.

When that happens the benign outcome is that rates stabilize — the bad outcome is that rates back up.

But the benign outcome still violates the premise on which asset prices are based and both they and the alleged commerce predicated on them collapse.

Ben Bernanke and Congress both, along with the Administration, have gone all-in on a series of lies, as have previous administrations and Congresses.  They all know these are lies as well — not only are they claiming that the so-called “recovery” is real (and not just a machination of The Fed’s games with the credit system) but in addition that it is sustainable, either currently or will be through these policies over time.

That’s a knowing lie because you cannot cheat mathematics and it is not possible to continue to drive interest rates lower indefinitely.

. . .

This administration and Congress must step to the microphone and tell the people the truth: The 30-year cycle of ever-decreasing borrowing costs, generated through both government and federal reserve manipulation and intentional falsehoods, is what caused the increase in asset prices during that time and the appearance of prosperity and economic progress.

We can no longer continue this whether we want to or not because the mathematical limits of this policy have been reached.

This decision should have been taken in 2000.  It would have resulted in a ~10% decrease in GDP, but then recovery — real recovery.  It was not and instead we chose to lie.

That decision could have been taken in 2007, and I strongly advocated for same.  It would have resulted in a 20% decrease in GDP, twice as bad, but we would have then recovered.  We instead chose to lie.

The decision now must be taken or it will be made for us, and we might see as much as a 40% GDP decrease in the short term.

We can no longer lie.

. . .

We’re both out of time and out of choices, and if Congress and the Administration try to kick the can any further we’re going to lose our future.

This stand-off on the debt and spending is good, not bad. Congress must not raise the debt ceiling. The government must balance the budget — now.

There’s more at the link.

Mr. Denninger is precisely and exactly right.  That is what’s caused the run-up in US asset prices. We’ve had no economic growth whatsoever over the past 30 years that wasn’t the product of cheaper borrowing costs. Those costs – i.e. interest rates – have been lowered due to massive and systematic government and central bank intervention – not by market forces. When that intervention ceases, those market forces will push them right back up again. (This began to happen earlier this year, when the Fed sought to back away from, or ‘taper’, its quantitative easing policy – even as it advised European central banks to increase theirs!)

What our politicians (and those in Europe and elsewhere) are clinging to, as a drowning man clings to a lifebelt or a rope, is that previously, central bank intervention kept on driving down interest rates, thus allowing them to borrow more and more money to sustain state expenditure that wasn’t sustainable from tax revenues.  That solution will no longer work, because interest rates are effectively near zero right now.  There’s nowhere left for them to go – except upward.

Politicians haven’t yet grasped this reality.  For decades they’ve been bailed out by their central banks, which have manipulated interest rates and printed money to allow governments to keep their fraudulent promises to their electorates with fraudulent money.  The central banks now have no more tools left in their toolbox.  They’re printing more and more and more money to keep things afloat . . . but there’s nothing backing that money.  As it floods the market, it simply drives asset prices into another bubble and destroys the value of national currencies.

I predict that the present Administration will continue its policies, no matter what, because it has to.  It sees no alternative.  Voters have come to depend on massive government subsidies to support their lifestyles.  Obamacare, Obamaphones, extended unemployment benefits (now reduced), fraudulent disability claims as a substitute for unemployment benefits, and many other subsidies . . . all are paid for in whole or in part by borrowing, because the government doesn’t have sufficient tax revenue to fund them all.  While doing that, other vital expenditures are slashed to the bone to free up more money for such programs.  Pension funds are left unfunded, because government (federal, state or local) needs the money it should be putting into them to bribe pay benefits to voters.

The Administration and Congress and the Senate are all trapped.  They can’t reduce spending without alienating the voters who put them there.  They can’t do that without losing their jobs at the next election.  They don’t want to lose their jobs.  Therefore, they’ll go on lying to us, and go on funding the economy and unsustainable government expenditure by borrowing more and more and more money, which their tame Federal Reserve and Treasury officials will obligingly arrange for them . . . until the whole thing blows up in their (and our) faces.

The truth is not in them.



  1. The reality that the pols face is this: if they tell the truth, they will be voted out, and/or crucified, because they will either have to admit incompetence and they didn't know, or admit they knew and they lied. Neither are acceptable to a ruler, because it nukes their huge self image and ego, it removes them from power, it destroys their legacy, and it crushes their (warped) worldview. They cannot admit this, ergo, the charade must go on, until reality reasserts itself, with a vengence… by which time all the long-time pols hope to be retired, and can blame the newly elected pols pols for crashing the system, with the willing support of the media.
    Consider decades of mismanagement and over-spending. Obamacare crushes the economy, and in 2014 the Republicans sweep to power in both houses of congress. With the media's help, Obama demagogues them daily, and the economy gets worse, and worse, and worse, because that was going to happen no matter WHO was in power. The Rs get the blame, and the Dems sweep to power, with Hillary at the top, in 2016, being seen as a "savior" from those evil, heartless, Rs. Things get worse, so a bunch of "emergency measures" are passed. And the charade will go on.

  2. Seems simple enough to me (but I do have my shoes off so I can count higher than ten 😉 – all that has to be done to maintain this 'system' is to continue to borrow – which in the case of fedzilla is by continuing to raise the debt ceiling and using continuing resolutions to keep thing afloat. We'd all end up in debtors prison if we ran our personal lives that way…………

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