Thursday, November 18, 2010

What Is the "Funding Crisis?" (My Contest Entry)

18 November 2010

I have entered a contest....

From Bill Fleckenstein's November 18, 2010 “Ask Fleck" column:

Reader question: Hi, You often mention a funding crisis. I looked it up on search and there are so many references. Could you please define what is a funding crisis???

Fleck replies: OK... let's have some fun with this. I have been describing the future funding crisis since early 2009, so rather than me do it one more time, let's make this a contest. The reader who does the best job will get a free one year subscription, and we will place that definition in “Fleckisms.” The deadline for entries will be this Friday.

OK. Here is my go at that one-year free subscription.

What is the “funding crisis?”

Let’s begin with two basic principles:

1. Any entity that spends money must also receive money to fund its expenditures.

There are two ways around this – credit and money creation (both temporary fixes).

What entities spend money and thus require revenues?

Basically all entities.

What entities have been spending too much money?

Basically, most of the above, but particularly the western nations and Japan, which have aging populations that have access to government-funded entitlements and require more of same, specifically health care and pension funds. Also – individuals and corporations in “bubble” sectors have been over-spending, often on the “wrong” things, such as overly lavish homes and productive capacity for items for which demand is not presently growing (this is called capital misallocation).

Is credit fixing the problem?

Well, it seemed to be doing so for a while. But individuals have over-borrowed, and now have difficulty repaying what they borrowed, particularly if they have lost their jobs or have reduced incomes for other reasons.

As to nations, again the western nations have been borrowing like crazy by selling bonds, and those who are not borrowing (read Asian and/or BRIC nations) are loaning them the money they need for expenditures, that is “funding” the deficits, the most egregious of which is that of the US, with something like a real $2 trillion annual shortfall in revenues versus expenditures and entitlements (promised future expenditures).

Also borrowing (like crazy) have been state (California, Illinois, etc.) and municipal governments and individuals. Corporations in non-bubble sectors have been more “sane.” Basically, most all (western) individuals and agencies are maxed out on credit, with many reaching the point of inability to repay it. Thus, creditors are beginning to question the wisdom of loaning money to individuals and government entities that are unlikely to repay them, particularly as they can no longer re-sell (“pawn off”) loan portfolios to imprudent “investors.”

Enter money creation, also known as quantitative easing, presently in its “QE2” stage. Central banks print new money to buy government bonds, thus inflating (and devaluing) the money supply. When money printing (massive) exceeds economic growth (stagnant), you're in trouble.

Thus, we’re in trouble now.

Only national governments and monetary authorities (specifically the European Union) can in most cases print money. So long as everybody is doing it, you have “competitive devaluation,” and one currency doesn't rise or fall that much versus another. However, some players are so profligate that they have no foreseeable ability to repay borrowed funds without money-printing, and at some point lenders are going to look at the bigger picture and decide they do not wish to be repaid in a sharply devalued currency (also known as “play money” or “monopoly money”) in exchange for “real money” loaned today.

A crisis represents a sudden shift in sentiment and behaviour in recognition of a gradually evolving picture of the world as it is. When those who loan money (buy treasuries) decide that they are unlikely ever to be repaid with anything of value (“real money”), they simply stop providing the revenues (cash flow) for the big spenders, in the present case, particularly the United States and some profligate European counterparts (known as PIIGS).

When treasury buyers stop funding government debts by buying government bonds, the bonds decline in value (reduced demand combined with over-supply), and interest rates rise until they are high enough that somebody (the “next fool”) starts buying them. At this point, we will see the kickoff of escalating interest rates combined with rising consumer prices and declining incomes and revenues, ergo, “the funding crisis.”

That is, the big spenders no longer have funds flowing in to cover their expenditures, thus necessitating a radical readjustment in either expenditures (drastically reduced) or the value of money (grossly inflated).

Coming soon (perhaps), to a government and/or nation state near you!

22 November 2010:

The winners to the "funding crisis definition" contest are now in. Mr. Fleckenstein has chosen the following two (hopefully the reader will not find my "essay," above, to be far off the mark):

The best reader definitions


A funding crisis happens to a country when other nations or institutions believe that the value of its sovereign debt or the value of its currency will decline significantly over time due to poor fiscal or monetary policies.

When that happens, fewer and fewer people are willing to purchase the sovereign debt of that country, leading to a sharp increase in interest rates and greatly increased difficulty in the ability of that country to raise new debt.

A funding crisis thus refers to the inability of a country to finance itself without resorting to outright money printing. This can lead to a vicious cycle of currency depreciation, rising interest rates, poor economic performance and poor investor sentiment, all of which feed on each other in a downward spiral.

A funding crisis can only end when proper monetary and fiscal discipline is restored, usually at the expense of severe economic hardship.

This one earned a tie as it was almost as good AND he used the search so well

In gentle criticism to the Rap Reader who inspired this little exercise, it may be useful and prudent to read a majority of those “so many references” pertaining to the “Funding Crisis”. I searched “Funding Crisis” and read everything that had a score of over 25. In this review, I discovered you started describing the “Funding Crisis” in the middle of 2006, but you did not give it a ‘handle’ until late 2008. I am glad I participated in this exercise as I learned a great deal and have a more clear financial picture of where we have been, where we currently are and where we may be going.

A Funding Crisis: the successor to the financial and economic crises; created mainly as a result of Federal Reserve policy over the last twenty years. A funding crisis occurs due to a lack of credibility in the Federal Reserve (and, the United States) to instill confidence in the value of the US dollar and repayment of current and future liabilities. The result of a US funding crisis is: a declining value of the US dollar and rising interest rates in debt markets.

My advice - if you want to understand the present economic situation, particularly in the US, do subscribe to Mr. Fleckenstein's moderately priced web service.


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