Where Are The Adults?
Peruse some headlines from this weekend:
The Pin To Pop This Mother Of All Bubbles?
“Metastability” Will Lead To “Cataclysmic Events”
Can We See A Bubble If We’re Inside The Bubble?
Undercurrents Of Worry
The Glaring Resemblance Between 2017 And 1999
Illinois In Massive Crisis
Tax Overhaul In Trouble
Fear Of Contagion In Italy
I can go on and on and on – but you get the idea.
In a nutshell – here is what is occurring:
What has been called the ‘Trump Trade’ is in doubt. The ‘Trump Trade’ was premised on political promises of tax reform, Obamacare repeal, massive deregulation, Dodd-Frank repeal, and so forth. These items appear to be in serious jeopardy due to the political climate in DC. Many markets inflated based on the assumption that these promised legislative changes would become reality. The more that doubt grows that these changes will become reality the more corresponding doubt appears that market investments predicated on those legislative items were a sound investment.
Despite what partisan motivated headlines may declare the economy is weakening – not just in the United States but also globally. Yield curves in various countries are inverting and this is a highly reliable indicator of pending recession. What is more – the demand for credit is weakening significantly. These are not signs of a happy healthy economy. These are reliable signs that the economy is likely to shrink rather than grow in the near future.
Over the last eight plus years the Federal Reserve and central banks around the world re-inflated the real estate and equities bubbles that burst in 2008 and 2009. This was primarily accomplished by adopting negative interest rate policies or zero interest rate policies. These policies by and large remain in place around the globe. The other tool the central banks have used the last eight plus years are liquidity injections. These continue even now at the rate of $200 billion a month being injected in order to keep the system solvent.
In other words – we have fixed nothing since the great meltdown almost nine years ago.
If we enter into a recession in the near future – what will be the policies? Interest rates going even deeper into negative territory? More asset purchases and liquidity injections by central banks? Undoubtedly that is what they plan. The problem with that plan is that every dollar of liquidity injected is marginally less effective than the previous dollar injected. For example, if you are my age and you had an Econ 101 class in college many decades ago you had a textbook that said something to the effect that “Due to the multiplier every dollar of credit introduced produces $4 dollars of economic growth.”
Many people still assume and believe that is true – but it is not. It currently requires about $4 of credit to be introduced in order to generate $1 of economic growth. That ratio has completely reversed – and it is only getting worse. Four years ago, every dollar of liquidity the Federal Reserve introduced produced 73 cents of economic growth – a terrible decline from decades ago – but not nearly as terrible as the first quarter of this year where every dollar of liquidity injected produced only 25 cents of economic growth.
It does not take a PhD to grasp the problem here – and to extrapolate out that in the case of a recession and massive amounts of additional liquidity being introduced that the return on credit will only decline further. The people in charge study Keynes and do not study von Mises and Hayek – if they did study von Mises and Hayek they would have realized long ago that the marginal decline in the effectivity of credit would have been the inevitable outcome.
These are real problems. These problems at some future point will overwhelm the petty melodramas that our politicians allow to engulf their lives and attempt to ensure engulf our lives.
In conclusion, reality is a bitch. All of the play-acting that constitutes American politics will not change the glide path we are on.
Where are the adults in the room when you need them?