knife edge economics

by: Keynesius Fraudius
2.27.2010
EarthBlog News©

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This essay proposes a set of assumptions to explain a set of empirical observations related to past, present, and future broad market behavior. There is no attempt to integrate geopolitical events such as war. The theory is called knife edge economics. It was first published privately to EarthBlog News subscribers in the spring of 2009 and disseminated publicly in late December 2009 via in an introspective look at the future of America. This essay offers an elaboration from that point.

knife edge economics

assumptions:

A collapse occurred in 2008 due to an ever increasing amount of debt which became too large to finance.

The FED is never going to tell the truth. Neither is the Treasury. Neither is the Banking system.

As short term interest rates were raised, the housing market collapsed, ending a multi decade long sting of FED induced serial bubbles which all required ever more debt.

The last bubble, the real estate bubble, was by far the largest bubble. The last remaining bubble is the unpayable debt still called a currency (the US dollar).

The collapse of the real estate bubble caused massive insolvency in the banking system, the government and the population. This set off a chain reaction of derivative failures with losses dwarfing available capital. This required public bailouts and state control of public corporations.

The collapse has already occurred, and all that can be done at this point is to alter the look and feel of the collapse, and affect real wealth and capital allocation as the collapse continues.

The entire global financial system at this point resembles a balloon. As new debt is created in the US, the capital is deployed overseas causing the balloon to expand and all asset prices to rise and the US dollar to fall because US banks are buying foreign assets and selling dollars. As the balloon deflates, capital returns to the US causing a rise in the US dollar and a deflation of all asset prices. The idea that capital returns to America seeking safety is an MSM red herring.

If the FED did not have a printing press available, the entire global financial system would have already completely collapsed amid massive insolvency into a deflationary depression and total system failure.

Since the FED does have a printing press, we have printed more money and increased the already unpayable debt so as to attempt to regain solvency of member banks and affiliated institutions.

Stability is achieved by ensuring low volatility. Low volatility is ensured by active short term market management.

If the volatility as measured by the VIX is low, the knife edge is wide. If the volatility is high, the knife edge narrows.

As the knife edge narrows (as volatility increases), the risk of falling off on one side or another increases.

The two sides of the knife edge are a: a hyperinflationary depression  b: a deflationary collapse

If the knife edge thins and collapse occurs, which side of the knife will be determined by how much money is printed (debt is increased).

If the knife edge remains wide (if the volatility remains low) , the collapse can be made to look like an extended period of economic and social decay lasting as long as one or two decades, ending at a point that resembles a collapse, but arriving there without a dislocation.

To the people, it will feel more of less the same. The experience will be high unemployment and a much lower standard of living due to unaffordability or lack of money.

The final outcome is either default or devaluation via inflating the debt away, or changing to a new devalued currency.

The FED, the Treasury and member banks along with Central Banks and affiliated institutions overseas are all working in concert using active management techniques of all kinds as a means to achieve policy objectives.

The primary policy objective is market stability.

The rate of quantitative easing (money printing) determines long term interest rates. Long term interest rates determine whether the FED is in control, or out of control.

The policy is to print enough money to keep long term interest rates low, so the real estate market and banking system can avoid continued collapse and regain solvency.

Artificially suppressing long term interest rate has the effect of depressing the US dollar which has the effect of boosting US share prices and commodity prices.

Using knife edge economics as a predictive tool, the ten year note and the VIX are leading indicators regarding collapse or decay. If the ten year yield remains low, then the FED would be assumed to be in control and the dollar would be free to slowly depreciate. The knife edge as measured by the VIX would remain wide, the FED would have more room to maneuver and commodity, stock and other real asset prices would be expected to move higher.

Another way to look at this would be that policy effect on asset prices is only a reflection of a depreciating dollar against all assets. In other words, assets like stocks may be going up, but only insofar as to reflect the decline in the worth of the dollar, which may or may not be well indicated by the US dollar index. The dollar would depreciate in this way possibly for a decade or more until the unpayable debt was inflated away.

If however there was to be a surge in the 10 yr rate, this would indicate a loss of FED control and would argue for much lower stock and commodity prices, along with a risk of a repeat of October 2008.

The FED solution for a market based surge in the 10 yr interest rate and a volatility increase would be to accelerate QE.  If printing money does not reduce the interest rate then knife edge economics would argue the FED is losing control and would risk hyperinflation to regain it with the alternative being insolvency and absolute system failure as was almost experienced in 2008.

Generally speaking, knife edge economics would explain current FED policy as endeavoring to promote stability through any active or passive means necessary. Keep the 10 yr yield low. Manage equity prices for stability and within bands. Allow the dollar to depreciate for an extended period of time, causing asset prices to slowly inflate to regain solvency within the system.

Editors note: EarthBlog News does not provide financial advice.  We are proposing an analytic structure to explain market behavior.

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  1. keith howell
    March 1, 2010 at 4:25 am

    Chaplain Lindsey Williams on Youtube says that an oil executive he has known for years declares that the doller will depreciate 30-50 percent by the end of 2010. What would be the cost of food, gasoline, etc if this occurs. Crude oil could be $150/bl if he is correct. This insider says that it is all planned.

    • March 1, 2010 at 4:47 am

      Thanks for the comment. I am aware of the theories that this is a planned demolition of the US economy in order to consolidate power. My thinking is that if this is true, then it would be only known for sure after the fact and would be accomplished by some kind of surprise devaluation or the introduction of a global currency. Please also see an introspective look at the future of America and two possible paths with the same endpoint.

  2. Rob
    March 1, 2010 at 3:19 pm

    Keynesius Fraudius 🙂

    Interesting, plausible, thought provoking. I would like to know more about how this idea is applied.

  3. Mike Lemmon
    March 2, 2010 at 3:41 am

    Great analysis.

  4. keith howell
    March 2, 2010 at 4:43 am

    This material is evidence of a valuable American, a most savy writer like Mike Whitney, Paul Craig Roberts, Bill Moyers, Jim Willie, Stewart Dougherty and others with keen insight into what is going on in the nation. We are fortunate to have 321 Gold, Informationclearinghouse, GlobalResearch.ca, and EarthBlog. You guys are courageous and genuine as opposed to those of the MSM whose writing are not worth a bucket of spit. Thanks.

    • March 2, 2010 at 5:20 am

      Thanks for the kind words. Regarding the MSM please see:

      a citizens guide to understanding corporate media propaganda (at the top)

  5. Kim
    March 2, 2010 at 5:09 am

    I like the graphic Keynesius !

  6. C.C.
    March 2, 2010 at 7:15 am

    Good piece.

    In retrospect (and the reading of blogs like yours here), I think it is safe to assume that anyone with a pulse – along with a reasonable measure of common sense, could see the financial hierarchy of the current debt-based economic system in the U.S., had no choice but to inflate – i.e., ‘ratchet-down value’ in as orderly a fashion as possible, the currency.

    Like Captain Hook said today in his piece titled ‘Just One False Move’. It is becoming more obvious as time quickly passes, that the Oligarchy/hierarchy is treading a very careful and clever path of PR, Spin and various tools and tricks (in the bond market) to bring this ‘thing’ back into a flight path that avoids catastrophe.

    The general public is way too ‘soft’ to accept the alternative, which would be a wash-out of ‘Too big to fail’ institutions and debt in general – both public and private. It would mean about 2 – 3 years of grinding hardship, but the ramp of recovery would be reasonably swift. Not likely to happen that way though, unfortunately.

    • March 2, 2010 at 2:07 pm

      Yes, I think it’s key to understand the aristocratic, oligarchical nature of media, politics and money in the US today. I discussed this in :

      the left vs right smokescreen

      People are being divided and conquered while Rome burns.

      At the lower right on my blog I have a link to all the essays of Paul Craig Roberts, former Asst Sec of the Treasury under Reagan. I would recommend everyone read all of his essays.

  7. rechelle
    March 2, 2010 at 9:43 am

    Hello, how do you see gold fitting into your analysis ? Tx

    • March 2, 2010 at 1:57 pm

      Thank you for your question. There is a hint at the end of an introspective look at the future of America.

      This is the sort of issue I wrestle with daily in the EarthBlog News. I don’t discuss my investment strategy side of the equation in public. I do trade for a living and I discuss that day by day in real time in the EarthBlog News, in the form of a daily trading diary.

      I would also like to add that I feel strongly that people should educate themselves so they are comfortable making their own decisions rather than listening to what I or anyone else is doing. Jim Rogers says the same thing. I would suggest reading everything he has written about investing.

  8. Tuftsflyer
    March 2, 2010 at 1:36 pm

    If I ever saw a scenario for a dramatic increase in the value of precious metals, this is it. Why does the financial media notdraw the same conclusion, or if they do, conceal what the Central Banks fear most, a gold bubble/

    • March 2, 2010 at 1:49 pm

      I’d like to address this question. Knife edge economics doesn’t exist in a vacuum. I have several other ideas and world views all related to this theory. One is that the money interests have in effect complete control over the media and the political body in the US. For that reason, gold will be always maligned because it effectively represents the alternative to their fiat money. For further reading, please see

      why do the worlds central banks manipulate the price of gold?
      who owns the FED and why don’t you know?
      a citizens guide to understanding corporate media propaganda techniques
      two possible paths with the same endpoint

      I believe if you have the time to read all of that and follow some of the footnotes, it will all become clear to you. The primary reason I started this site was to educate, or at least to offer a plausible explanation for why the world is the way it is today. This is all old news for EarthBlog News paid subscribers as I have discussed these topics there for a long time. If you are interested, please see “about earthblog news”.

      Craig Harris, Editor.

  9. March 2, 2010 at 1:39 pm

    Clear, concise, insightful and on target !! Great minds simplify complexities. Thank you. Looking forward to your continuing analysis of unfolding events. And oh by the way, God bless and help my country.

  10. March 2, 2010 at 1:46 pm

    You mentioned that the Fed’s policy objective is price stability. That may be a temporary goal, but I am convinced that the ultimate goal is the consolidation of monetary power in the hands of the government and a few investment banks. The Fed and the U.S. govt. have created a crisis situation which they do not want to totally collapse. They are using the crisis for very strategic purposes of power consolidation, and eventual world govt.

    • March 2, 2010 at 2:01 pm

      I agree 100%. For most people it takes a lot of background knowledge to come to this conclusion. I was discussing this very topic along with the mechanics of how I see it all playing out last night in EarthBlog News.

  11. bill
    March 2, 2010 at 2:05 pm

    how about arch crawford….his july..august 2010…warning ..any thoughts..

    • March 2, 2010 at 2:29 pm

      I try not to mix astrology with my money:) My wife mixes it with everything else. I don’t know what he said. Sorry I can’t be more help on that. I tend to be independent as a thinker and I don’t like to be influenced by what other people say. That has been an evolution over 30 years of trading. I watch the markets all day every day, but I can’t remember the last time I turned on CNBC. It was a long time ago. I don’t like to mix propaganda with my money either.

  12. Lawrence
    March 2, 2010 at 3:31 pm

    The “best” outcome from this whole mess would be an extended Japan-style depression. However this is unlikely given the much understated and still inherent systemic instability.

    The analogy of the knife edge is never more apt. So will it be hyperinflationary depression or deflationary collapse? Although the FED control the printing presses it is debatable that they can inject enough money fast enough should a major collapse like that seen in Oct 2008 occur again, WITHOUT major loss of dollar confidence.
    Therefore a deflationary collapse seems the more likely of the two taking outstanding derivatives and debt loads into account. If interested further please see:

    The Risks of a Catastrophic Deflationary Collapse
    http://www.financialsense.com/fsu/editorials/2009/1103.html

    comments always welcome

    • March 2, 2010 at 3:50 pm

      Thank you for the comment.

      In my view, there is a serious problem with the deflationary collapse argument. The problem is that in order to save themselves, they have to prevent a deflationary collapse into insolvency. They have a tool (the printing press) which can prevent that, and that has been the course taken so far. Hyperinflation or even very high inflation/stagflation may not be good for the citizens, but they have the tools to profit from that, further consolidating wealth, power and control. (please see profiting from the demise of America). I do not believe the welfare of the American Public is a consideration in FED policy. I believe the primary consideration is how a syndicate of international central bankers can ever increase their wealth, power and control over the worlds population, who they view more or less as inferior beings or serfs. (please see who owns the Federal Reserve and why don’t you know?)

  13. C.C.
    March 2, 2010 at 4:36 pm

    Thank you for that last one, Craig. I made a comment in an op-ed piece a while back to the effect of: ‘It’s all Political Now’.

    And it is.

    It is all political in terms of cause & effect, outcome and consequences. The level of corruption is so deep and wide in the sphere of ‘political finance’, that it goes right over the head of the easily led – of which, comprise the majority of our population, as witnessed by the nonsensical daily ‘debates’ and ‘news’ stories over non-issues like ‘health-care’ and ‘terrorism’.

    Bottom line: If your ‘gut’ is telling you something ain’t quite right out there with the direction we’re going along with a simple graph that plots economic events from around 1975 onward, then start ‘squirreling’ away what you can and what you know you need to.

    Despite what some would suggest, we are in Different Times. With the level of debt, derivatives and unfunded liabilities outstanding, I would suggest we are in Exponentially Different times…

    Best to everyone

    -C.C.

    • March 2, 2010 at 4:44 pm

      Hi C.C.

      Yes, you are on a critical, key point. Thank you for punctuating it. It’s my belief that you can’t analyze what’s going on today in the pure economic realm. It’s all part of a much larger thing. This is what a lot of people who deal exclusively in the realm of finance are missing, and as a result I think are coming to the wrong conclusions. What I am trying to do here at the public site is to offer an overview of how it all fits together. In other words, when I’m done here, I would hope someone could read all the essays and then say “ok, I get it now”.

  14. bill
    March 3, 2010 at 2:43 pm

    it is funny how we all seek enlightenment and direction from so many diverse sources…yet when a newsletter..economist with an extremely accurate trackrecord (many many times more accurate then any of his piers)..comes out with the starkest warning of his lifetime …we say we do not mix astrology and investing..allright then…I myself think Arch is VERY credible no matter what his methods are..(based on past return ratings.)…yet you mention astrology and people laugh..I go with track record…also I do believe MAHENDRA is biased for some unknown reason..just a thought

  15. tj
    March 3, 2010 at 4:20 pm

    great article
    i think very few understand the level of manipulation going on in the markets now. predictions are of limited value when massive intervention is occuring,i like the way you think. thanks

    • March 3, 2010 at 5:01 pm

      thanks.

      The topic of market manipulation is an important one. This issue used to be the bastion of “conspiracy theorists”, however with the CEO of trimtabs recently coming forward to say all his data points to government manipulation, I think the cat is out of the bag.

  16. keith howell
    March 4, 2010 at 4:51 am

    Craig, you have a great web site, with live feeds, blogroll, recent posts, reader comments, immediate feedback and fantastic links to other critical sites. How do you do it all and moreso, when do you sleep?

  17. T
    March 4, 2010 at 4:25 pm

    Interesting analysis you have here. I like unconventional thinking because conventional thinking is always just following the herd. Interesting site too. I liked the one on the FED. I learned a few things I wasn’t aware of from that.

  18. keith
    March 4, 2010 at 5:46 pm

    T, the problem with the nation is that our entire national government is no more than a crowd of self-serving, greedy, power hungry idiots who could care less about the concerns of citizens, who are supported by a controlled media, and funded completely by corporate interests, plus a military establishment totally out of control. We are no longer a democracy, certainly not a democratic republic, but truly a corporatocracy. The truth only comes to us from those few courageous souls who give a damn about America and who have the balls to speak the truth. I hope that censorship in the name of national security does not interfere with the free flow of information. My hope is that the White Hats inside the DOD, the CIA, and the NSA can keep the nation together. God help us if they cannot.

  19. March 7, 2010 at 1:16 pm

    A bubble in, say, shares, stocks or commodities happens when people believe it will “go up and up” (and is, as a rule, as with housing recently and “tech” stocks at the beginning of the millenium, again mainly driven by money inflation). Gold in contrast is a hedge against inflation and against looming sovereign defaults. Inflation by definition is the increase in money supply. There’s no doubt that this has happened several fold in only two years. So there is inflation. Hence there is no gold bubble, as gold has not appreciated by a tenth even of what the monetary base has expanded!

  20. March 7, 2010 at 6:25 pm

    REALLY GOOD AND INFORMATIVE BLOG THANKS

  21. Stan
    March 9, 2010 at 4:19 pm

    I love this knife edge theory because it’s all based in reality rather than most of the lies I’m supposed to believe like some mindless oaf.

    In other words, when someone fails to acknowledge the now obvious manipulation of asset markets, or the fact that the FED and Treasury are liars, this de legitimizes everything else they are about to say. Thanks for interjecting some reality into the discussion of markets and finance. Are you saying that so long as the 10 yr stays low, the knife edge is wide and stability is more likely?

  22. March 9, 2010 at 7:49 pm

    Thanks to everyone above for the kind words. I haven’t had time lately to visit and reply to each comment individually, but I’ll try to address this last question from Stan.

    Knife Edge economics would say that if the 10yr were to rise in yield (fall in price) on a sustained basis, confirmation would be expected by a rising VIX, rising USD and equity and commodity market selloff. This selloff would continue until the FED provided enough liquidity via quantitative easing to flood the system with money and cause a retreat in the long term interest rate.

    A continued rise in the ten year yield despite active QE measures would according to knife edge economics indicate a loss of control and raise the odds significantly of a fall off of one edge or another into collapse. As long as the ten year remains in check, according to KEE we will experience prolonged decay rather than collapse.

    I have discussed the in’s and out’s of this at length with EarthBlog News Subscribers and I am using the idea extensively in my own trading.

  23. Anonymous
    March 10, 2010 at 12:10 am

    A friend sent me a link here. This blog should be called “you can’t handle the effin truth”. Really nice blog whoever you are. I thoroughly enjoyed my visit !

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  1. March 1, 2010 at 7:25 pm

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