I am hoping for push-back here, so please poke holes! Question my assumptions! Help me think this through!
Looking at the past 20 years, it is clear we have an increasingly fat jockey (wealth) riding a faltering horse (the real economy). This might continue for some time, but it can’t continue forever. The resolution is likely to be ugly – either via the fires of asset write-downs or the freezer rot of inflation.
If I were alone in that view, I’d doubt my own judgement or facts or both. My reading this summer has given me courage to write this post. A former head of the Bank of England sees those same imbalances (see Mervyn King’s “The Alchemy of Finance“). Two respected heavy-hitters spotlight “the” major cause of those imbalances (see “Trade Wars Are Class Wars“). So I’m not alone in seeing those imbalances or worrying about an ugly resolution. I may well be alone and wrong in the below, but here goes…
Over the last 20 years, the US has pumped a huge volume of dollars into increasingly stagnant pools of non-circulating paper wealth. The money has piled up much faster than the economy has grown. Those stagnant pools might give us a rough estimate of “the Bezzle.” Paper wealth that exists only as long as a financial confidence game lasts.
“At any given time there exists an inventory of undiscovered embezzlement [not the illegal kind. The legal, clever Wall Street kind. Think 2008’s mortgage backed bond bubble] in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks. https://www.goodreads.com/quotes/tag/bezzle
There is a lot more cash-per-dollar-of-GDP sitting around than there used to be. Since 2008, the amount of money sitting around has doubled (+100%). The real economy has only grown by half (+50%). All as measured by declining monetary velocity (see prior post for the velocity data etc. here).
- Since 2008, GDP has grown 48%. Money has grown by 94%.
- Since 2000, GDP has grown 115%. Money has grown by 296%.
- Most of the “excess” money has been created via the various Fed interventions especially Quantitative Easing (QE). Fed Chair Ben Bernanke once said; “The problem with QE is it works in practice, but it doesn’t work in theory.” In other words, the placebo effect.
- All these numbers are up to 2019. Pre-COVID.
- “Money” here means ready cash. MZM – US bank deposits, checking accounts, money market funds, etc… Notably, it does not include money sitting at the Fed (“excess reserves”).
The scale of that mismatch suggests a Bezzle does exist. The above gives us a guesstimate measure of the (inherently un-measurable) Bezzle. A lot of paper wealth sitting around that isn’t backed up by the real economy. An increasingly fat jockey on an increasingly enfeebled horse.
If GDP and money had stayed in rough balance, either GDP today would be much higher or Money would be much smaller. The difference might give us a rough estimate of the Bezzle. If we make the (potentially very false) assumption those two number series re-synchronize, then the catch-up-effect requires that…
- …either nominal GDP grows much faster to catch up with the money supply (inflating away the value of those “Bezzle” assets)
- …or a big chunk of paper wealth evaporates to shrink “money” back down to proportion with GDP (deflating those “Bezzle” asset values by potentially violent write-downs).
In dollar terms, we either need to write off $4 to $8 trillion of “Bezzle” paper wealth, or inflate the Bezzle away by increasing nominal GDP by $7 to $18 trillion (with no real dollar increase in wealth). This assumes a catch-up effect. Either we grow nominal GDP faster than “money” or we shrink “money” to re-proportion it to GDP. For context, GDP in 2019 was $21.4 Trillion. So destroying $4 to $8 trillion of paper wealth is 20%-40% of one year’s GDP. Brutal and worryingly plausible in size.
The longer we keep this up, the bigger those stagnant pools of paper wealth get. Making for an uglier reckoning. This is the problem with any embezzlement or Ponzi scheme. The numbers eventually compound until the edifice collapses under its own weight. Which is arguably why the policy response to COVID has been so frantic. Trying to push an ugly reckoning into the future. Piling up more Bezzle that will, eventually, have to be destroyed via the fires of asset write-downs or the freezer rot of inflation. Or, maybe, more wisely, trying to over-print enough to tilt a resolution in the direction of (less-destructive) inflation instead of deflation.
Either way, we are left with that fat jockey on that thin horse. The jockey is getting fatter and fatter. Eventually the horse must falter. Maybe not this crisis. But sometime somewhere.
This crisis might be big enough to force the issue. We’ve seen a huge move into stocks recently. At a time the real economy looks extremely shaky. We all know the stock market can be an incredibly efficient money destruction machine. One day you wake up and 30% of it just is gone. Poof. Like what happened in, say, March 2020.
Yes, values have come back since then. Based partly on a placebo-effect belief in a “tidal wave of Fed money” that has not actually circulated into markets or the real-economy (see prior post here). But there is no iron law saying the market has to recover from the next crash. On 2019 numbers, US equity markets were worth about $40 trillion and global markets add another $50 trillion. A $4 to $8 trillion hit to “wealth” (5%-10% of global value, 10%-20% of US market cap value) is a worryingly plausible chunk of that paper wealth.
It might not happen through stocks. Real Estate and Bank Loan markets take longer to adjust (it took ages in 2008-2011). But all asset markets will, eventually, do their job of destroying paper wealth that isn’t supported by real-world cash flows. Usually over-correcting downwards before leveling out. So we could “lose” $8 to $16 trillion (on a $21.5 Trillion GDP), and bounce back up from there.
There is a huge mental chasm between a “temporary market pullback” and a “permanent loss of wealth.” People will spend through a pullback. But if/as they figure out the Bezzle is never coming back… Same quote below with a different sentence in bold. It could foretell a much less exuberant future…
“At any given time there exists an inventory of undiscovered embezzlement [not the illegal kind. The legal, clever Wall Street kind. Think 2008’s mortgage backed bond bubble] in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks. https://www.goodreads.com/quotes/tag/bezzle
We might avoid a resolution this time around. We did in 2008. Extend and pretend… Moreover, this piece could just be howlingly wrong. Please push back. And/or please forward this on to someone/anyone who might be able to push back at it (please forward me the replies no mater how brutal). I’ll learn the most from the push back. Two immediate caveats where I am obviously “wrong.”
- There are all sorts of valid reasons why money supply and monetary velocity might never rebound. Big permanent demographic shifts especially. Also the impact of low rates, foreign trade, etc… So the ENTIRE underlying premise here is also questionable. Still interesting perhaps. But there is no God-given reason this catch-up effect must happen.
- This is in no ways a “valid” economic analysis. A real economist would justifiably tear this whole piece to shreds. But the worship of false precision is the hobgoblin of small minds (and most Economics departments). I still think this sort of “analytically leaky but directionally interesting” analysis has value. It is clearly faulty, but it shines a light on something we otherwise can’t measure. So it might remain useful.
