The world is awash in credits.
The dollar -- a Federal Reserve Note -- is actually a debt instrument. And when you hold one in your hand you are technically holding a credit.
It is backed by promise which is backed by another promise.
If that were not enough, the real slight of hand takes place electronically.
Electronically there are far, far more dollars than there are actual paper dollars backing them up, so it's probably more accurate to say that the world is awash in electronic credits. Such is the terrible truth of fractional-reserve banking.
So we're left with a major supply and demand problem. We think there is far more "money" than there actually is.
This dirty secret is what makes the following so important. It's from Jeffrey P. Snider at Alhambra Investment Partners and was found on Zero Hedge via David Stockman's Contra Corner blog.
Snider just discussed something that has been near and dear to my heart since the dollar went parabolic during the carnage of 2008: the possibility of a shortage of dollars.
Lately it looks like it's setting up for a possible redux.
Causation: malinvestment.
Snider explains:
"The ratio of capital to consumer goods production has continued to climb and is currently just down a smidgen from a recent new all time high. If one compares capital and consumer goods production side-by-side, there is now an unprecedented gap between the two. We believe this is a result of the artificial suppression of interest rates by monetary pumping. Note in this context also that the huge issuance volumes in the junk bond market in recent years are by themselves already indicating that a lot of malinvestment is in train. These economic activities would under normal circumstance never get this much cheap funding. We can be quite certain that a lot of the associated investments will eventually turn out to have been misguided." (emphasis mine)
"When interest rates are artificially suppressed by large additions to the money supply, more and more investment tends to move toward production processes temporally distant from the consumer stage. This is because under conditions of monetary pumping, price signals in the economy are falsified. Longer production processes that would normally be avoided because they are not in line with society-wide time preferences suddenly appear to be profitable, and it is only later revealed that either the real resources to complete them are lacking, or if they are completed, that they simply cannot be continued without incurring major losses once the price structure has normalized."
A most elegant description of malinvestment.
"For the stock market (and other “risk asset” markets like junk bonds and also higher rated corporate bonds) this means that the fundamental backdrop that makes a major denouement possible is definitely in place now."
Snider also quoted a recent IMF study, publicized in the Financial Times, which noted that Asian corporations are more short dollars than previously estimated:
"Residents of emerging markets owe hundreds of billions more dollars (and euros) than previously thought, because they have sold bonds offshore that don’t get counted in national statistics…
"This borrowing creates a currency mismatch. As long as the dollar (or euro) doesn’t appreciate too quickly against the borrowers’ local currencies, the debts can be easily serviced. The danger is that these large short positions could cause a squeeze and create a desperate search for scarce dollars — exactly what happened in 2008."
Like the derivatives time bomb, no one knows exactly how large it is.
"The basic analysis of the dollar short – nobody really knows much about it. It exists independent of any statistical measure and in far too many cases, including and especially policymakers, independent of knowledge and experience (closed system? The dollar short is the empirical refutation of all closed system approaches in economics). As it is in 2014 we are still finding out it is probably bigger (IMF) and more widespread than even thought now after seven years of close involvement with it.
"That makes the indirect indications provided by TIC and dollar “flows” all that more concerning, especially as they represent a sort of proxy for liquidity health and systemic capacity. At some point it may become necessary for “someone” to provide all these “dollars” and if everyone is all short then there will be no one left to take up that side (rerun of 2008).
"There is a clear diminishment in “excess” dollar supply."
Snider warns "the private sector continues to disfavor dollars, or, to put it more precisely, is far less assured of their availability."
Mass belief in the promise backing the promise is the only thing that makes the game possible. Sudden disbelief = sudden crisis = Game Over.
Snider continues, "You only need to glance in the crisis period above to see what happens when you combine a lack of dollar participation with negative sentiment turning onto fear. As dollar shortages spread in 2008 (especially heading toward Phase 2), participation dropped and so did dollar asset prices of everything."
Food for thought as the world's central banks pull out all the stops in order to buy time. In a world of assets priced for a weak dollar wrapped up in a world of credit and debt, crisis is not an option.
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