Albert Einstein once said, “The definition of insanity is doing the same thing over and over again and expecting different results.” Does this ring a bell? How often do you see this very quote played out every single day? When I lived in Costa Rica I saw this every day in so many different ways. Many of their “customs and practices” are based on “it’s just how things have always been done.” Never mind the results or lack of, “this is the way we do it.”
But here in the States we are “smarter,” right? We would never fall into this “insanity trap” because we are too smart, too innovative… Well, what got us into the “Great Financial Crisis” in the first place? …Maybe too much debt or something like that? Have we changed anything since then to change course? In fact we have, we have changed (increased) the volume or the intensity of the creation of new debt and “money.” All you need to do is look at nearly any chart of money supply or debt, the rate of increase has increased which in layman’s terms means that we are in fact doing the “same thing” only we are stepping on the gas harder and doing the same thing on a bigger scale. In essence, we are trying to change a light bulb with a hammer and swinging it faster and harder…while expecting a different result! Insane?
Ah…but the Fed sees the error of their ways and will announce a “taper” where they slow down swinging the hammer…this will work. Just as you can picture what a light socket and bulb would look like after hammering it, picture the financial system. The global system was “reflated” time after time over the years to turn and exit recessions; it worked…it ALWAYS worked. Before I go any further I need to point something out that is very important. “Recessions” since WWII and prior to the year 2000 were “engineered.” When I say “engineered” I mean that the Fed actually created them on purpose…EVERY SINGLE ONE! The Fed would see the economy or assets getting too frothy and they would raise interest rates to slow the economy, create a recession and clean up “mal investment” that had accumulated in the last growth phase, this was called “taking the punchbowl away before the party got out of hand.” Then, when they judged that the economy had wrung out enough “bad debt” they would lower rates and “reflate.” This is how it was done…until…
The 2001 recession (some say that 1991-92 was when the Fed first understood that there could be no more recessions). The Fed did not “engineer” the 2001 recession, actually they lowered rates to try to avoid it but the effects of lower rates had less effects than in the past. Then came 2008, interest rates were VERY slowly increased from 2003 or 04 into late 2006…when we were told not to worry because the Fed was starting to ease. They eased and eased yet real estate did not turn up and defaults were increasing at an increasing rate…the magic elixir wasn’t working like in the past.
Plain and simple, the accumulated debt from all of the past “reflations” (especially since 1971 when we went off of the gold standard) pushed us into levels best described as “debt saturation.” This was the point where few could take on more debt and many were defaulting…but…we had to REFLATE or DIE so governments themselves stepped in to take on more debt and reflate. We have seen over the last several years that sovereign governments themselves have hit the “wall of debt” where investors want no more and interest payments on their own are difficult to pay. My point here is that until the 2001 recession, the central banks created recessions and then ended them…because “they could.” They now know and have known for many years that they must avoid any recession like the plague otherwise we will have a debt unwinding that cannot be stopped which incidentally will affect the currencies because they are “debt based” themselves.
Sorry for the history lesson and I know that you are thinking “but I already knew this.” Yes you probably did but has the Federal Reserve done everything in their powers over at least the last 5 years to “reflate” again by adding more money and credit…at incrementally faster rates? Was it insane? Did it save us? Are we actually growing or just treading water? “Tapering” is merely slowing the rate of monetization and creation of new debt…but, isn’t this exactly what the Fed was afraid of in 2001 and again every single day since 2007? A contraction of debt? OK, maybe not a contraction but the “rate of increase” slowing which when all is said and done under the current structure the same thing as an outright contraction?
Mark my words, if the Fed announces a “taper” (and it doesn’t even matter how much), within a month or maybe even much sooner the credit markets and FOREX markets will go into a grand mal seizure. By the middle of October we will be back to where we are now, the Fed will be “QEing” and telling us that they have it all under control. The only problem is that even Joe Sixpack will then know that the Fed has lost control. I might add that the debt system is now so much larger than it was in 2008 and market participants whom gave the “benefit of the doubt” last time around will not this time. A market seizure will not be calmed this time with some paltry $700 billion TARP plan or the Fed quintupling their balance sheet. The debt has gotten so large and so out of control that Hank Paulson’s so called “bazooka” will be a joke this time around.
I started this piece by basically stating that the Federal Reserve got us into this mess through following the “definition of insanity.” Tomorrow they will most likely tell us that they can now back away from the insanity. They cannot, they maybe could have some 20 years ago but it would have been extremely painful. Now, the markets will demonstrate to the Fed just how late they are to coming to their senses and just how dire their insanity over the last 100 years has really been. The patient will die on the table this time around even with pure adrenaline being pumped directly into the heart. The old saying “cash is King” before recessions and crashes will hold so very true this time. However, “cash” in this case must not only be liquid but also a fortress like store of value. Gold will stand tall as everything else flammable goes up in smoke as another reflation is impossible.