Category Archives: Markets

The Great Unmasking

Last month, Donald Trump caused a stir in the economic world, with his analysis of the Federal Reserve and its monetary policy during an interview he did with CNBC.

In it, he was adamant that the zero interest rate policy of the Federal Reserve had created a ‘false stock market.’ This was after last week, in which he had said that the interest rate policy had created a ‘false economy.’ His reasoning for both was that the decisions were political in nature.

According to Trump, Janet Yellen, the Federal Reserve Chair, was embarking on these policies in order to help President Obama, in order to make sure he ends his term with a positive economy.

Politics aside, the administration, and most left leaning economists have quick to point to the job numbers as a sign of the recovering health of the economy. The fact that the stock market has made fresh all time highs in 2016 has been used to tout the strength of the business community and commerce. Indeed, at a campaign rally last month, President Obama vociferously patted himself on the back for an economic job well done:

Janet Yellen, during her remarks explaining the Federal Reserve’s interest rate decision on September 21, painted a rosy picture of the economy, repeatedly citing the employment figures along with household income increases as evidence.

It is my view that these data points – mainly the employment data, and the performance of the broad stock markets – are merely masks which give the perception of strength and improvement, while concealing a deteriorating reality underneath.

The Labor Market Mask

Let’s look at the employment data.

While it is true that the unemployment rate has come down to 5%, from about 10%:

Part of that is because the labor force participation rate has declined throughout President Obama’s tenure and is at multi-decade lows:


With a ‘normal’ labor force participation,  the unemployment rate would be much higher, at least 10%.

The problem isn’t just with the totality of the workforce and the employment rate, but with the types of jobs which are being created in this economy, and who is filling them. Even a cursory look at the below surface trend reveals some problems.

The following is a breakdown of the labor force participation rate by age group: (Credit to the excellent Doug Short, who is a tremendous resource with his charting)


The following chart shows the breakdown in cumulative job gains for prime age workers versus those over 55, from 2007 through August 2016:


The following chart shows the cumulative gains in the food and hospitality industry versus manufacturing:


These charts show that the labor force is getting older, and the jobs that are being created are mostly of lower quality, in terms of goods producing. The bartenders vs manufacturing chart is somewhat tongue in cheek, but it does highlight the fact that most of the jobs that are being created are in the service sector, which are less paying jobs. The jobs that are being lost are the higher paying goods producing jobs.

Also concerning is he fact that the jobs data for September 2016 showed an increase in part time jobs of 430,000, compared to a loss in full time jobs of 5,000. In addition, there was a spike in the amount of individuals who hold multiple jobs of roughly 300,000, from 7.5 million to 7.8 million. The following two charts highlight these developments:

part-vs-full multiple-oct

Put it all together, and what we have is an economy which appears to be creating low paying jobs, which are being filled by people who may already have jobs, but need second and third jobs. Or, individuals who were laid off from a full time job, and are replacing it with multiple part time jobs, at lower pay.

Regardless, these are not signs of a robust economy, and those who point to headlines touting ‘X million jobs created since the recovery’ are being duped by an attractive mask that hides a horror show.

The Asset Price Mask

But what about the stock market? Isn’t it at all time highs?

It is, but masks are present here as well. Namely, the Federal Reserve. For nearly 8 years, the Federal Reserve has been engaged in unprecedented levels of monetary accommodation, with the Federal Funds rate resting at 0% until the most modest of raises in December 2015.

That raise was supposed to be the start of an easing cycle, which many experts predicted would result in four rate hikes for 2016. However, the stock market subsequently began 2016 with the worst start in the history of the stock market. This prompted an abrupt about face from the Fed, and then the ‘experts,’ with respect to the rate hiking schedule. Four rate hikes became two, and two became one, and as of this writing there is talk that there will be none at all.

That 12% stock market sell off in the first three weeks of 2016, on the back of the Fed raising rates for the first time in 7 years, from 0% to a negligible 0.25%, is indicative of the whole story: This market lives by the Fed and dies by the Fed. Some, myself among them, would call that a bubble.

The Fed’s persistence in keeping interest rates as low as possible is ultimately rooted in its flawed belief that elevated asset prices are the key to prosperity. Consider Ben Bernanke’s 2010 explanation of accommodative monetary policy and its intended result, the ignition of the ‘wealth effect.’

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

This is a description of an economic growth model that starts with the Fed lowering interest rates, pumping money into the economy, continues with various actors in the economy increasing their borrowing, and ends in them buying assets, which increase their prices, emboldening the owners of those assets to further spend or take on more debt as a result of their increased ‘collateral.’

The hope Bernanke and all Keynesian influenced central bankers had, and still have, is that this process continues and feeds on itself, a phenomenon known as the ‘virtuous cycle.’

Indeed, the Federal Reserve has accomplished this, expanding its balance sheet from roughly $800 billion in 2008 to roughly $4.5 trillion today:


Which has led to skyrocketing corporate debt:


Which has, in part, led to a substantial rise in the S&P 500, which I will use as a proxy for ‘asset prices’:


The problem with this, the Fed’s preferred model for growth, is that continued asset price increases rely on ever expanding debt, to provide the impetus to buy. It is a simple fact that debt cannot expand in perpetuity. It is limited by the ability to service that debt, which is in turn limited by the productive capacity of the borrower in question.

With respect to corporate borrowers, that productive capacity is seen in earnings. If corporates can produce increasing earnings, they can sustain larger debt loads, which justifies the higher debt-induced prices. The following chart, of the S&P 500 index compared with earnings of the companies in that index, tells an interesting tale:


In short, the continued rise in stock prices are not justified based on the diminishing productive capacity of the companies themselves. A reason for this diminished capacity is general weakness in the economy itself, evidenced by the labor market situation which was discussed earlier.

An economy in which more and more people are working multiple lower paying part time service jobs instead of higher paying full time goods producing jobs is going to be an economy in which fewer and fewer people have incomes which allow them to spend freely. These household budgets are further constricted when taking into account the fact that the Fed is trying to engineer prices higher, so as to kick start the ‘virtuous cycle’ of the ‘wealth effect.’

The math just doesn’t work. Rigid incomes lead to constrained household budgets, which do not lend themselves to increased spending at higher price points, nor do they lend themselves to increasing borrowing to spend at higher price points.

Despite this roadblock, share prices continue to remain elevated, because the continued low interest rate environment established by the Fed enables corporates to take up the burden of spending. They can borrow at record low rates, and buy back stock. Or, other investors, banks, foreign central banks and others can borrow at low rates, in order to buy elevated stock prices. The rationale here is less a belief in a prospective restoration of business fundamentals, and more in a belief that buyers will buy for the sake of buying, rendering elevated prices becoming even more elevated.

Even the Fed is worried about the developments they have created:

In the minutes of the Fed’s September meeting, released this week,some officials “expressed concern that the protracted period of very low interest rates might be encouraging excessive borrowing and increased leverage in the nonfinancial corporate sector.”


Despite these worries, investors continue to demand corporate debt, helping fuel a years-long rip-roaring rally in corporate credit that shows few signs of stopping. Corporate bond issuance this year is set to total $1.5 trillion, nudging past last year’s tally, according to the credit strategists at HSBC, led by Edward Marrinan. Issuance of high-grade debt is expect hit [sic] another record high this year.


It’s all a sign that, in the words of the bank’s strategists, “Market participants seem to be downplaying—or looking past—the risks associated with the steady deterioration in the credit fundamentals of the US corporate sector,” such as rising leverage, contracting earnings, and stressed revenues.


After the financial crisis, many companies focused on rebuilding their balance sheets to withstand another shock. But as the prolonged period of low interest rates continued, cheap borrowing costs prompted, well, more borrowing. Much of that went to fund shareholder-friendly activities like dividend increases and share buybacks. It also funded big mergers and acqusitions.

Emphasis mine. The preponderance of ‘shareholder-friendly activities,’ not least of which being the explosion of asset prices themselves, looks very good on the surface. Indeed, many law makers, academics, and market cheerleaders (such as President Obama) have been in a celebratory mood over the last few years, boldly declaring that the Federal Reserve’s actions had worked.

However, the divergence described by the WSJ – that the Fed itself worries about – between elevated asset prices and the fundamental deterioration of those prices is real, and cannot persist in perpetuity.

Removing the Mask

Deteriorating fundamentals cannot support the further debt burdens that are required to keep asset prices rising even further beyond these levels. And the Fed knows it. This is why they abandoned the original plan for multiple rate hikes in 2016, as that would have slowed down borrowing and thus slowed down the impetus for asset price increases.

In this manner, the market going from four expected rate hikes to now one or zero rate hikes is an effective rate cut. This is what the Fed has been relegated to, sitting on its hands and hoping a miracle happens. If they are proactive in doing anything more accommodative, such as another round of QE, they will put themselves in an untenable position. They can’t on one hand tout the robustness of the economy  yet embark on further emergency policies, such as QE would be. The situation would be exposed for all but the most die-hard believers in the Fed.

Regardless of their games, or ‘forward guidance’ as they would call it, reality will assert itself at some stage. The mask will eventually come off. How exactly it will happen is uncertain. But this situation has happened several times before in financial history. There is no escaping a scenario in which too much debt has been taken on relative to the ability to service it. All the Federal Reserve (and central banking in general) can accomplish is to push the date of reckoning out into the future. But even that does damage.

The current boom/bust episode is merely the latest in a 40 plus year credit binge following the ending of the gold standard in 1971. This has eventually led to constantly rising asset prices, which fooled the majority of the public into eschewing the idea of accumulating real savings.

Most used their home or 401k as their savings account. This was fine as long as the stock and housing markets kept rising, which they did, temporary bear market corrections notwithstanding. That all changed in 2008, when the bubble burst in earnest, and asset prices crashed.

This resulted in mass layoffs, but more importantly, many who had counted on elevated real estate and stock prices for retirement were now out in the cold, just at the moment they were ready to retire. This meant they were forced to return to the labor market, because they had built up no real savings over the preceding decades. This explains the surge in labor force participation for the over 55 segment, discussed earlier.

The under 55s have struggled to regain a foothold during this latest ‘recovery,’ still being several million jobs underwater from where they began the Great Recession. Some of this is down to competition from the over 55 workers, who flooded the market. Many of them, closed off from their former occupations, went into parts of the market usually populated by younger workers. Hence the proverbial ‘Wal-Mart Greeter.’

That position really should be filled by a 16 year old kid, working his first job and acquiring the basic skills involved with employment. Instead, the position is filled by a 60 year old who is working one of his last jobs because he didn’t accumulate savings during most of his productive years.

This phenomenon doesn’t bode well for the economy as a whole going forward. When you have an economy which is severely under-employing those who are in their peak earning years, not only is the economy not going to be moving as robustly as it should, but in the future, as those workers persist with decades of under-employment, they too will have to encroach on future younger generations as they try to get their careers off the ground. Multiple generations impaired at once.

And therein lies one of the ultimate problems with central banking, played out over decades. It, like most of government, prioritizes political expedience over longer term sustainability, papering over the cracks instead of repairing them, thus consigning the ultimate costs to be dealt with in the future.

In this greater sense, reality will assert itself here as well. The exponential increase in debt and increases in money supply papering over business cycle after business cycle can only end in a currency crisis, as it has done many times in the past. One can only hope we correct course before such an event occurs.

Where did the Inflation Came From?

Matthew Klein at the FT asks this question in a blog post he did earlier this week. The obvious answer is ‘The Federal Reserve,’ with their stated goal to make sure that the increase in prices is always a positive number. Klein writes:

Central bankers think steady price increases are a good thing. After all, inflation makes it easier for employers to cut real labour costs and helps monetary policy boost the economy without having to lower (nominal) interest rates below zero.

As an aside, Klein is correct about the intentions of central bankers. In times of recession, pressure is generally put on all prices to fall, including wages. Keynesian inspired central banking seeks to substitute a nominal fall in wages for a real fall in wages, by increasing inflation so that prices rise. The price of goods rises faster than the rise in wages, creating a real fall in wages. This policy sounds fine on paper, but leads to many problems, as I’ve outlined in the past.

Whether or not you agree, we thought it would be interesting to look at which products explain the rise of American consumer prices since 1990. As it turns out, just as the bulk of the growth in employment can be attributed to a few sectors where productivity is either low or unmeasurable, a whopping 88 per cent of the total rise in the price level boils down to four sectors of the US economy:


The accompanying chart shows that these sectors, healthcare, housing, education, and prescription drugs have accounted for the bulk of the rise in consumer prices. Klein then goes on to list several areas in which the price level has declined over the last 25 years or so.

By contrast, thanks to astounding technological innovation, television prices have plunged at an average rate of 12 per cent each year since 1990 and computer prices have fallen more than 18 per cent per year:

Price stability in goods can’t be attributed solely to higher screen resolutions and faster chipsets, because plenty of other physical objects resisted the inflationary trend. The prices of new motor vehicles only just surpassed the highs set in the mid-1990s. “Recreational books”, as distinct from “educational books”, cost the same now as in the late 1990s. Musical instrument prices peaked in the early 1990s and have since drifted lower. Watch prices are the same now as in 1990, and that’s only because of a recent upward spike earlier this year.


Luggage — luggage! — prices have plunged about 44 per cent since the mid-1990s. The prices of “dishes and flatware” have fallen 49 per cent since the peak in 1998 and the prices of “household linens” have dropped 60 per cent from their peak in 1992:

(We suspect the emergence of Asian manufacturing and the admittance of China into the World Trade Organisation were more important to these developments than dramatic spurts of innovation, but we could be persuaded otherwise.)


Less surprisingly, “telephone and fascimile equipment” is 78 per cent cheaper than the peak in 1997, in a remarkable reversal of the previous bout of price increases:

In general, the prices of durable goods are about a third lower now than in 1990, while the prices of nondurable goods excluding commodity products (food, drinks, and fuel, which tend to rise at the same rate as the broader price level over time) and excluding prescription drugs, have also fallen, albeit not by as much. Inflation outside of healthcare and education has generally been modest, with the notable exception of a few small professional services such as tax preparation, lawyers, and funeral homes.

The sectors in which prices have exploded (healthcare, housing, education, drugs) all have one thing in common: heavy government involvement over the period of time in question. The housing bubble, Federal Student loans, and increasing healthcare regulations have taken their toll on customers in the shape of rising prices.

The areas in which prices have fallen the most, such as technology and other areas, are relatively devoid of regulation. This is how a freer economy works – increased innovation leads to more efficient production and better products, which drives prices down. This enables more and more people to consume these products, spreading the innovation to as many people as possible. It is precisely the lower prices, which central bankers fight against, which allow this to happen.

Note also the fact that the sectors in which prices have risen are all necessities. This represents the height of the failure of central planning. Regulations and middling by central banks produces inefficiency and rising costs for the consumer, while freer markets produce continued lower costs and improving products. It is really that simple.

Is Oil Weakness Ahead?

The WSJ certainly thinks so (emphasis mine):

Surging demand from drivers in the richest countries helped power a big rally in crude this year. But many analysts say that surge is ending.


In the U.S., lower gasoline prices led consumers to drive a record three trillion miles in the past 12 months. In June, gas consumption hit an all-time high, 9.7 million barrels a day. And in July, pickup trucks, SUVs and other gas guzzlers reached a record share of auto sales.


Yet as the summer-driving season ends, low fuel prices may not be enough to entice consumers to pump in more gasoline. More broadly, economic growth isn’t strong enough in the U.S. and Europe to produce the necessary increase in jobs or new manufacturing that would spur large, long-term increases in oil demand…


….Many traders, pointing to stockpiles that are holding or even growing, are betting that a glut hasn’t eased enough to keep supporting this year’s rally.


Data last week showed U.S. stockpiles of crude and refined fuels growing to a record. Supplies of crude, gasoline and diesel are so high that even record demand hasn’t been enough to balance the market. Global gasoline storage has been filled to a near-record level all summer, almost 500 million barrels, according to Citigroup Inc.

I’d certainly agree with that, but mostly for technical reasons. Over the last three years of this oil bear market, there has been a seasonal pattern. A low early in the year, followed by a slow melt up through the spring, and a June/early summer top which gave way to declines through the fall. The following chart highlights this.


The three arrows indicate the early year bottoms in 2014-16, and the gray circles indicate the early summer tops, and potential top of this year. This is far from certain of course, but owing to the continual bearish fundamentals, the existence of bearish technicals as well does not bode well for oil  bulls.

In the moderate to long term (at least 18 months to two years), I am rather bullish, as I expect global central banks to further ease monetary policy, leading to a rise in asset prices and commodities. Before this happens though, I do believe there will be one last swing lower to demoralize people. I’ve always maintained that the price would approach $20 at some stage. We shall see.

On #Brexit

At the end of last year, I was struck by the following quote from this article in the FT, which tried to set the table for the coming political year in the West.

Countries such as France, the UK and the US are already multicultural and multifaith societies. Attempting to reverse those social changes is both unrealistic and a recipe for conflict. It is legitimate, however, to insist all citizens subscribe to certain values, to make multicultural societies work.

To me, it was emblematic of the fundamental problem with progressivism in all forms – it is completely focused on maintaining short term comfort above all else, and it has the seeds of its own destruction within its tenets. And here was the FT brazenly putting forth that line of thinking.

This sort of religious adherence to maintaining the Status Quo, regardless of its effectiveness,  is often justified by an appeal to one’s aversion to the unknown. The biggest banks and corporations, for example, simply had to be bailed out by taxpayers and central banks in the aftermath of the Financial Crisis, because the alternative would have been unknown, and therefore worse. Thus, the system and all its machinations, which had brought about the one of the worst panics in the history of the modern economy, had to be maintained at all costs.


23rd June 2016 has the potential to go down in history as a date in which those costs finally proved to be too much for the average citizen to bear. In voting to leave the European Union, Britons sent a message to the globalist elites – We’ve Had Enough.

The nature of the EU itself made it a foregone conclusion that a portion of its membership would eventually reach the conclusion the Brits did. The EU, in short, is a soft fascist dictatorship. Before I get accused of hyperbole, here is the dictionary definition of fascism:

A system of government marked by centralization of authority under a dictator, a capitalist economy subject to stringent governmental controls, violent suppression of the opposition, and typically a policy of belligerent nationalism and racism.

While there is no singular face of EU dictatorship in the vein of a Hitler or Mussolini, the collection of ‘Eurocrats’ in Brussels, all with their unwavering promotion of ‘The European Dream,’ does suffice. Indeed, even the most ardent proponent of the EU admits, through gritted teeth, the existence of the euphemistic term ‘democratic deficit.’

The endless regulations emanating from Brussels satisfies that condition of fascism relating to government control of the capitalist setup. In terms of suppressing the opposition, the means the EU favors is a combination of outright ignoring certain democratic decisions made by voters, and a perverse level of political correctness which shames people into submission. To date, the EU doesn’t point guns at its subjects per se; rather it points the threat of being labeled racist, xenophobic, or Islamophobic.


Consider the fact that the St. Georges cross is increasingly being redefined as a racist symbol of hate, such that English people who proudly display their national flag are deemed racist by extension. The aim is to suppress pride in English culture and heritage, so as to replace it with the amalgamation of ‘European.’ As such belligerent nationalism is merely replaced by belligerent pan-Europeanism.

Even of one still refuses to agree with my assessment, one cannot deny that the EU at the very least saddles its citizens with yet another layer of bureaucracy which must be waded through. It’s of little surprise that, with stagnating growth and a slow and steady decline in industry over the past four decades, Britons decided to have a rethink as to the virtues of EU diktat, and the ‘open market.’

Then, of course there is immigration. David Frum, writing in the Atlantic, had this to say about the immigration issue as it pertained to the UK.

The force that turned Britain away from the European Union was the greatest mass migration since perhaps the Anglo-Saxon invasion. 630,000 foreign nationals settled in Britain in the single year 2015. Britain’s population has grown from 57 million in 1990 to 65 million in 2015, despite a native birth rate that’s now below replacement. On Britain’s present course, the population would top 70 million within another decade, half of that growth immigration-driven.


British population growth is not generally perceived to benefit British-born people. Migration stresses schools, hospitals, and above all, housing. The median house price in London already amounts to 12 times the median local salary. Rich migrants outbid British buyers for the best properties; poor migrants are willing to crowd more densely into a dwelling than British-born people are accustomed to tolerating.


Is it possible that leaders and elites had it all wrong? If they’re to save the open global economy, maybe they need to protect their populations better against globalization’s most unwelcome consequences—of which mass migration is the very least welcome of them all?


If any one person drove the United Kingdom out of the European Union, it was Angela Merkel, and her impulsive solo decision in the summer of 2015 to throw open Germany—and then all Europe—to 1.1 million Middle Eastern and North African migrants, with uncountable millions more to come.


David Brooks, another mainstream writer, voiced similar concerns during an appearance on PBS Newshour following the vote. In it, he expressed sadness at the result of the referendum, but his real regret seemed to be that the elites merely pushed too hard in their actions. In other words, they had essentially dumped too many immigrants too soon on populations like the British.

This sort of mass migration set about a culture clash which had been bubbling under the surface for years, but is rapidly coming to the fore. The mainstream progressive narrative of the joyous nature of multiculturalism is becoming exposed as less than truthful on almost a daily basis. In the quote I opened this piece with, the FT insisted that because multiculturalism was already here, it must persist, albeit with a base level of values everyone must adhere to.

This sort of thinking goes out the window when you have to start handing out pamphlets to which explicitly detail that things like hitting women and children, fondling or groping women, and urinating in swimming pools, among other things, are frowned upon.

This is further exacerbated by the existence of a generous benefits system. The truth, which is becoming more apparent by the day, is that open borders and generous welfare states cannot coexist. One must pick one or the other. A failure to do so will lead to a situation in which new entrants to the country don’t even have to learn the language in order to be taken care of. And from there, the host culture is on the path to a slow, but sure destruction.


These realities made the EU an unworkable construct, and the Leave vote an inevitable one. Given the Remain coalition was made up of the vast majority of government officials, in the UK across Europe, and worldwide; academia, mainstream media, and multinational business interests, it is clear that the referendum was also in part a referendum on the viability of the elites and their globalist agenda.

In rejecting the bid to stay in the EU, the voters made their thoughts clear. In response, so did the elites, as it were. The night of the referendum, I watched the BBC broadcast of the results trickling in. As the Leave vote looked more and more certain, the mood of the panelists and the hosts continued to sour. The grave mood was befitting the death of an important head of state, or an act of terror, rather than a democratic vote to determine the level of self-determination the country would have going forward.

In the days following the referendum, the media have played up the ‘buyer’s remorse’ angle, using the movements in global financial markets to buttress their arguments. All of a sudden, the fact that the Leave campaigners may have exaggerated some of their claims is evidence of callous treachery, despite the fact that politicians have never been strangers to such discrepancies between rhetoric and action. In most cases, however, the discrepancies favor the dominant narrative, and as such are swept aside.

More cynically, they have attempted to paint a picture of the average Leave voter being an uneducated white racist from a rural part of the country, while prominently featuring anecdotes of anti-immigration abuse both on and offline.

That these sorts of tactics have been generally well received, and even amplified on social media reinforces the fact that the progressive, globalist view of the world is still the most dominant, if not the most loudly proclaimed. On Twitter, sentiments such as the following were put forth as the new reality for the future of Britain in the context of Europe as a whole.


This picture, posted on twitter, was supposed to represent the ‘cost’ of Leave, in that the fine wines, pastries, fruit and waffles of the continent were to be lost, with only the drabness of baked beans left for the British to enjoy.

A shockingly high number of people don’t see the inanity of that attempt to crystallize the Brexit consequences. It isn’t as though the UK is going to start floating off into the Atlantic Ocean, away from the continent. The goods and services the continent does well are still going to be accessible in the UK, and vice versa.

More importantly, those delicacies are only made possible thanks to the differentiation in cultures that exist. In prioritizing this push to a ‘European’ culture, you lose Italian Culture, French Culture, German Culture, Spanish Culture, and so forth. The attributes unique to each culture and group of people which are responsible for the products known and loved the world over are lost in the transition to an amorphous blob of dedifferentiation that is pan-Europeanism.

For those who purport to champion the superiority of diversity, it is strange that they can’t seem to understand that such diversity is only possible if, at some level, peoples are permitted to do things their own way. In this regard, the negative stigma applied to nationalism is unwarranted.


One of the more curious aspects of the vote and the subsequent fallout is the complete lack of foresight shown by those in the media, financial and political class. It was all but assumed that the Remain vote would win the day, and as such the stock markets around the globe moved higher in celebration.

A huge part of the reason for the optimism came from the fact that the most recent polling had shown a clean victory for the Remain side. That actual voting resulted in a firm victory for the Leave side pointed to the fact that there was a significant ‘hidden’ Leave contingent.

The explanation for this is that the Remain position was touted as the view which ‘respectable’ and ‘tolerant’ members of society held. Thus, it is natural that anyone who dared to see some logical points in the Leave argument would want to keep it to themselves so as to not subject themselves to the emotional shaming tactics which are part and parcel of the progressive/globalist toolkit of debate.

In other words, normal, hardworking, respectful people who are not by any means racist or xenophobic were kept silent in public simply because they dared to disagree with the Remain argument. In the privacy of the ballot box, where the threat of ostracism was voided, they were able to make their voices known. This dynamic is the antithesis of a free society.


As such, the result of this referendum is only the beginning, or as per Churchill, the end of the beginning. Fascist dictatorships just hand their power away once it has been attained. Ideologies which depend on bullying those for the crime of disagreeing don’t admit defeat when outclassed in logical debates. It is vitally important that Leave voters make the result stuck by establishing a government that will follow through on the referendum’s aim.

David Cameron has volunteered to step down as Prime Minister; he must be replaced with a PM who was an ardent Leave campaigner and has no qualms about going the full distance. Half measures will only make things worse.

As I mentioned earlier, the subsequent financial tumult is being used as evidence that a mistake was made. S&P, a ratings agency which should have no credibility owing to their shenanigans leading up to the last Financial Crisis, has cut the credit rating of the UK. Any further fall in markets, or slowdown in the economy will be blamed on Brexit. As will any future terrorist attack which takes place anywhere in Europe.

These claims would be unwarranted. For a start, the global markets have been on a knife edge for nearly two years, making minimal gains in that time, on aggregate. The ‘recovery’ of the post Financial Crisis in developed economies has been tepid at best, with policy makers attempting to blow a bubble to replace the last bubble which popped in 2007.

It is only a matter of time before the post Financial Crisis bubble pops, and it is true that Brexit may be the straw that broke the camel’s back. But that is only because of the existence of the other straws.


If Brexit is to be truly successful, it will be because it rids itself of the EU morass completely. That means replacing the rules and regulations which hampered British industry with…nothing at all. It must totally eliminate the extra layer of bureaucracy instead of merely replacing it with another, more British flavor. During the campaign, many Leave proponents pointed to the success of Switzerland as a model for the UK post EU. What was less mentioned was the fact that Swiss success owes largely to their greater degree of liberty and lesser degree of regulation and government control, in comparison to their continental neighbors.

Unless Britain goes down the same path as the Swiss in all aspects, the Brexit vote will not be a blow to globalism. Rather it will be a loud scream from a tied up victim which can easily be rectified by a strategically placed piece of duct tape.

In terms of this larger context, as a person who favors less government, less regulation, and a higher level of liberty for individuals, I am enthusiastic about what happened on the 23rd of June. Even if it turns out to be a false alarm for the globalists, the cat will be out of the bag. Through events such as this and the US election, the public is becoming more and more aware of the fact that their disillusionment is not without merit and the policies of progressivism and globalist thinking are mostly to blame.

The media, big business and political establishment which have got this wrong, and have been getting it wrong will start to lose their influence. The proliferation of the internet has meant that information can no longer be controlled and shape to fit the ‘approved’ narrative. Ideas and narratives must now stand on their own two feet, which can only bode well for the values of liberty and freedom.


The stakes are high. Even before the Brexit vote, there were growing sentiments across Europe that the EU project is disagreeable. Anti-EU sentiment was already much greater in many countries around Europe, which suggests that multiple referendums along the lines of Brexit are on the way. Should more countries leave, the financial, political, and cultural burdens will be that much greater on the remaining countries, which will further increase the discontent. This downward spiral could essentially be the way the EU ends.

It will be the breakdown of the post-WWII order, a paradigm which was 60 plus years in the making. If elements of it have proven to be a failure, it is right that these elements are dismantled and replaced with something better. That will not come without pain, or discomfort. It is not unlike the pain the body most endure when going through chemotherapy. However, if the end result is a cancer free life, the temporary loss of hair, weight and general sickness and discomfort will have been worth it.

That point, perhaps more than any I’ve made, is the most important one to get across, for we live in a world which has a hyperfocus on short term comfort above all else. If the very culture that affords us the many comforts we enjoy is to be maintained, the opposite focus must be attained. Historically, only a major crisis has forced people to change their thinking. Much of the promise in the Brexit vote lies in the fact that the emergence of longer term thinking at the expense of the short term has happened before the point of existential crisis.

It is a sign that there is hope for those who value Western Civilization and want to see it preserved and propagated.

On Tesla’s Model 3 Fanfare

Tesla is one of, if not the most polarizing companies out there, from an investment perspective. You are either a 100% believer in every word that Elon Musk says or you believe that the company is the ultimate hype job. There is usually little scope to be somewhere in the middle, but I am just there.

I do believe that Musk is potentially a transformational figure in the same vein as Henry Ford and Bill Gates. At the same time, Tesla’s ambitions are not backed by the marketplace. They have been at best marginally profitable, and have been trending towards markedly unprofitable in the last year, and rely on substantial government subsidies.

The unveiling of their new Model 3 last week was met with all sorts of fanfare. Bloomberg have even declared that the car has already lived up to the hype, despite the fact that it will not be available until late 2017. This morning, they’ve announced that over 325,000 people paid a $1000 deposit for the car.

In truth, that doesn’t mean very much, beyond the great press. The deposit can be recalled at any time, and as such it is basically a loan from the depositors to Tesla, who will use that money in the production process. The risk for Tesla is that between now and the eventual release date, problems may arise which lead to mass refunds of deposits, which put the company in an even more precarious financial position than it is in. Those problems may include things a simple as the $35,000 price point moving higher, or the release date being pushed further and further back. The Model 3 really has to be a home run for Tesla.

Personally, I hope that it is. But with regards to its stock, I cannot justify the stratospheric levels to which it has risen. Quite frankly, TSLA is a company with a great story but very little of substance to back it up (at this time). It could very well come through in the end, but such premises are not what good investments are made upon. A look at the history of the stock is below:


TSLA has achieved its great heights mostly on the back of hedge fund driven momentum buying, a feature of the now 7 year bull market from 2009. Regardless of its financials, the hype of Tesla has been the impetus to new highs.

One investing in this stock would do well to wait until Tesla actually develops a track record of consistency in its sales, projections and deliveries on a lot of the promises Musk has made. In terms of the short term action, it is my belief that it will rally to new all time highs, besting the $291 mark it set in 2014. Naturally, $300 might be a magnet. But from there I do not see how there is much upside, especially given I believe we are in the early stages of a bear market generally. Or, at the very least we are in the beginning stages of a substantial (20-40%) correction in the general market.

Should that be the case, the momentum stocks like Tesla are going to be the hardest hit, and as such one should steer clear of them. That said, a massive decline in the stock would be welcome news for real investors. Looking ahead to late 2017, the potential confluence of a much lower stock price much in line with its current fundamentals, and a smooth Model 3 release, would be a fertile ground to plant the seeds of a good investment.

That time has not yet come, however. Playing in Tesla at this stage is a gamble, and participants should act accordingly.

Market Update – Bears Last Stand?

The last five to six weeks have been quite painful for those who are bearish on equity markets, as they have been swept aside by a short squeeze which has been historic in nature. The US markets opened the year with its worst start on record in response to the rate hike of December 2015. This led many, including myself, to believe that a 2008 style year was on the cards.

My view is still that we are in a bear market, or at the very least in the midst of a real correction, the likes which haven’t been seen since 2012. This is based on the basic fact that the Federal Reserve, which has been the main driver of the now 7 year long bull market, has for at least 2 years taken its foot off the gas. The impetus for equity price appreciation has now gone, and it is still my base case that there will not be any new highs in the S&P 500 without the Federal Reserve going back on its current normalization path.

Janet Yellen may have already reversed course, given her extremely dovish speech at the Economic Club of New York last week. This reverse course has come in the shape of a reduction in the number of planned rate hikes for 2016, from four to two. It remains to be seen what actually happens, but if the Fed stays where it is, it is unlikely that prices much higher. Having said that, the rally from February 10 has been impressive. Below are two charts of the S&P 500 futures, over the last four years, and the last three months respectively:


The white moving average on all charts is a 55 period moving average. The top chart, a weekly chart spanning 4 years, shows that indeed the bull has at least come to a resting point over the last 18 months. Momentum, which is indicated at the bottom of the chart, has also stalled out and acted negatively over that time frame.

The main point of contentment for bulls is the failure of prices to break the 1800/1850 area, as indicated by the yellow band. Particularly impressive was the hold and sharp rebound in early February, which has been the genesis of the current rally. This rally is highlighted in the second chart above. It has been quite orderly, respecting the moving average as it slogs higher, further demoralizing bears. It is at a key area though. If the bears are to remain in control, price is going to have to stall out here and reverse lower. Should we see 2100 again, it will surely be the time to throw in the towel in terms of shorting the market. It wouldn’t necessarily be a time to open new long term positions, given the flirtation all time highs, but it would be a significant defeat for those looking for a significant correction to the long term bull. As a result, I believe that the next few weeks of price action will be Incredibly important.


Crude Oil Futures


The following is a chart of Crude Oil over the last 20 years or so:


The devastating move lower since 2014 has been one of the major talking points in finance. On a technical basis, I believe that the easy money has already been made on the short side, and there is a limited downside to come from here, at least in terms of a nominal price decline. As you can see, I’ve drawn in levels at $25 and $17ish, which are roughly 30-60% away from current levels. That is no slouch in terms of profit potential.

My current view is that price ‘wants’ to see something in the low $20s, and perhaps even lower if there is a capitulation type of move. It would make sense technically as well, given the fact that $25 is a major bottom, as is the $17/18 area. $20 is a major psychological level as well.



Having said that, there is a lot of talk about the bottom in Crude, which is why I suggested that the ‘easy’ money has been made already on the short side. There is constant talk of production freezes and reductions, which are meant to boost prices. I do think the simple fundamentals are going to prevent any material price increases for now, and the technicals support that as well. The top of the two charts show the action over the last 12 months, which is decidedly bearish.

The bottom chart shows the current upswing, which like the one in stocks began in early February. Price is currently at an extremely important level, $36ish. A break below would probably see prices quickly deteriorate, back towards $31. Holding at these levels and trending back towards the $40s may indicate that a legitimate respite from falling crude oil prices may in fact be on.




The above weekly chart represents the last 4.5 years of action, all of it spent declining from the peak of 1923 in September of 2011. As you can see, it has respected the moving average up until the beginning of this year, when it spiked higher. A closer look at the move below:


I’m inclined to believe that gold has made a secular bottom, and will now resume the uptrend that it began way back in 2001. In terms of a shorter term outlook, the move from 1050 to 1287 is in the process of being retraced. I’ve highlighted a band which should be instructive. Holding those levels and making a further high from here should confirm that the bull market is back on. Breaking back lower towards 1050 suggests it hasn’t begun just yet.


US Dollar




Another of the major talking points in finance over the last four years has been the performance of the US dollar. It has been a one way street for 4+ years, going higher, as is shown in the first chart. The second chart shows the churn prices have faced over the last 18 months or so.

Telling price action for me was the move to new highs in late 2015 followed by an abrupt reaction lower. This suggests to me that the next major move in the Dollar Index is lower, and price is seemingly in the process of travelling along that path. Early targets are the range lows at 92, and failing that, the area between 86 and 90 is one of great interest.


Until next week, happy trading.

Just Say No, to Monetary Drug Abuse

I like to say we injected cocaine and heroin into the system, and now we’re maintaining it on Ritalin.

  • Richard Fisher, Former FOMC voting member, 9 March 2016

Here is the solution to the American drug problem suggested a couple years back by the wife of our President: “Just say no.”

  • Kurt Vonnegut


Nancy Reagan died a little under two weeks ago, and one of the things she’ll be most remembered for is her campaign against drug use, and the famous slogan: ‘Just say no.’ Whether her efforts were effective are debatable. At the very least, they did ignite a national conversation about drug use that was useful.

In my personal opinion, drug addiction is closely related to a lack of hope, or a lack of appreciation for the future. If one doesn’t believe any sort of positive future is in the offing, it is more likely that drugs become appealing. Not only do they create an escape from that lack of future, they provide comfort in the present. Despite the destructive nature of drug abuse, it is understandable on some level.

Unfortunately, policy makers in the economic arena also share the drug addicts’ lack of hope when it comes to future prospects in recessions. When statistical metrics such as GDP, and projections such as the output gap begin to deviate from the plan, policy makers turn to the monetary drugs of interest rate cuts and asset purchases. They ultimately see no hope for economies in slowdowns, and must ease them away. As with the drug abuse, the high is only temporary, and it doesn’t change reality. To the extent the user continues, he or she only engages in self harm.

A few days after Nancy Reagan passed, the European Central Bank’s eschewed her pleas to ‘just say no,’ and chose to increase its version of Quantitative Easing, and to further reduce deposit rates. The full details of their monetary policy decision are below:

Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

(1) The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%, starting from the operation to be settled on 16 March 2016.

(2) The interest rate on the marginal lending facility will be decreased by 5 basis points to 0.25%, with effect from 16 March 2016.

(3) The interest rate on the deposit facility will be decreased by 10 basis points to -0.40%, with effect from 16 March 2016.

(4) The monthly purchases under the asset purchase programme will be expanded to €80 billion starting in April.

(5) Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.

(6) A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility.

As usual, the real fireworks came in the press conference after the decision was released, in which Draghi made his usual attempt to please everyone. The monetary doves who believe that the ECB hasn’t been loose enough with the monetary spigots got something to cheer in the announcement itself. The more hawkish who believe the ECB is being far too loose also got something when Draghi declared that this set of policy easing would be the last for the foreseeable future.

What interests me in all of this is the base attempt by yet another central banker to control an economic situation which is not going according to plan. Ever since the Great Recession, central bankers the world over have been engaged in a constant battle with the marketplace. The American version of this battle is as follows: the marketplace wanted to (and still wants to) effectively restructure the debts incurred during the go-go years of the housing bubble. Doing so would have resulted in a cascade of bank and corporate failures, asset price declines, layoffs, and defaults of various kinds. To be sure, a lot of that did happen, but it would have been a lot worse had central bankers not acted, as Draghi defiantly pointed out multiple times during his press conference.

This stance, that ‘the counterfactual’ would have been utterly devastating for Western Civilization as a whole stands as a blanket justification for mainstream economists, government officials, and commentators as to why the efforts of central bankers since 2008 were beneficial to the respective economies. The economy was a patient bleeding from a gunshot wound, the analogy goes, and the central bankers were the surgeons in the Emergency Room. Unfortunately, it relies on a bankrupt understanding of economics, which, as I will show, not only led us to pursue the wrong course of action in 2008, but will lead to the ultimate demise of the economy as we know it should it continue.


Economic Growth, and How Best to Attain It


Even though my contention is that the central bankers of the world have got it wrong, I will concede that at the very least, they have good intentions. They ostensibly want to achieve steady economic growth, and to do so with as little unemployment as possible. So where are they getting it wrong?

Let’s start from the beginning. Economic growth is a process by which the scarce resources on this planet are fashioned into goods and services which help to satisfy the many needs and wants of man. To the extent that these goods and services are better and/or more plentiful than before, the standard of living of those affected will rise. This process begins with a producer anticipating a future want or need, continues to the producer acquiring land, labor and capital, then producing the product or service, and delivering that product or service to the market. The last stage of the process is the consumption of the good or service. Reiterated for the more visual readers:

How Economic Growth Happens In A Market:

Identification/Anticipation of Unmet Want or Need

Gather Land, Labor and Capital


Delivery to Marketplace


At any given moment in time, resources are finite, thus how they are used becomes important. At the same time, there are many producers who are competing for those resources so they can attempt to satisfy the needs and wants of consumers which they have determined. The producers which get to realize their vision as opposed to those who don’t is largely determined by price. More specifically, the price of land, labor and capital, the price of the money which is borrowed to procure them, as well as the price at which those final goods can be sold.

As prices change in the market, the prospects for producers’ projects change with them. Policy makers understand this – which is why during recessions, they seek to stimulate investment by lowering the rate of interest. This lower cost of borrowing means that more of it can be done, which in theory leads to more investment and production. An unencumbered marketplace seeks to stimulate investment just the same. Its method is different from that of policymakers, in that it works via the reduction of prices and a rising rate of interest. When this occurs, the lower prices also bring costs down, which then means that the price a producer then has to command to clear a profit becomes easier to achieve.

A word here on the idea of a ‘deflationary spiral,’ the possibility of which was referenced by Draghi in his presser as ‘disastrous.’  The idea that ‘deflation,’ defined as falling prices in the mainstream, is to be avoided at all costs is a big part of Keynesian theory, some variant of which has been the dominant economic dogma for the last 80 years. This reticence among policymakers is because falling prices in recessions lead to falling profits, which lead to rising layoffs and liquidations, which lead to more falling prices, and profits, theoretically driving the economy into a ‘spiral’ like vortex. Therefore policy seeks to maintain a rising price level. This underscores the consistency among policymakers, and academics of all stripes in assigning a positive connotation to rising prices and a negative connotation for falling prices.

Taking the theory out and returning to the real world exposes this predilection for inflation for what it is – nonsense.  Central bankers the world over are declaring that if the prices of goods and services economy wide go up by a certain amount each year, the economy will be in great shape. If the prices for rent, food and gas went down, however? Chaos must be lurking.

Of course, the fear of falling prices neglects the fact that humans have never ending needs and wants, such that the price level will never ‘spiral’ to zero. At some level of prices, there will be demand for goods, which means there will be an interest for producers to supply that demand. Once that price level is found, the engine of economic growth can begin anew.

Some Methods of Stimulus Are Better Than Others

Invariably, recessions happen. The short explanation for them is that humans make mistakes. To be slightly more detailed, the economic growth machine can stall for various reasons. Producers may misinterpret the need or want for their goods. Too much of them may be produced. They may be produced inefficiently. Consumers may have changed their tastes. Whatever the reason, slowdowns in economic growth are always going to happen, the same way any path to success will have blips or setbacks along the way.

The true measure of success, without being too cliché, is not how many times one is felled, but the response to each fall, and how and if one gets up. With respect to economies, how the inevitability of recessions are responded to is of utmost importance.

The difference between a policymaker and freer market method of restoring investment during recessions ultimately boils down to the following: Policy makers prefer lowering interest rates, combined with other measures, with a goal of propping up the price level. The market, left alone, would be inclined to higher interest rates with a falling price level. From the perspective of the producer the lower interest rates/higher price combo means that ultimately a higher price is required for their final goods to achieve a profit. The higher interest rate combined with a price level left to find its true means a lower price for final goods is then necessary to make a profit.

Prior to the Federal Reserve, recessions more or less played out via the market raising interest rates, dropping prices, and allowing the chips to fall where they fell. A clear example of this is the ‘Long Depression,’ a description ascribed to the period from 1873-1879. My analysis of this period comes from the work done by Milton Friedman and Anna Schwartz in their book A Monetary History of the United States, 1867-1960. I’ll start with the conclusion first: it is questionable that this period (Friedman and Schwartz start with 1869 in their analysis) really constituted a depression on the whole, given the economy improved in virtually metric over the course of the period. The following chart illustrates this:


A more qualitative description of the time period is given by Friedman and Schwartz below:

There are many other signs of rapid economic growth. This was a period of great railroad expansion dramatized by the linking of the coasts by rail in 1869. The number of miles of track operated more than doubled from 1867 to 1879, a rate of expansion not matched subsequently.


In New York State, for which figures are readily available, the number of ton miles of freight carried on railroads nearly quintupled and, for the first time since the figures began, exceeded the number of ton miles carried on canals and rivers…. The number of farms rose by over 50 per cent from 1870 to 1880 for the U.S. as a whole. The average value per acre apparently increased despite the sharp decline in the price of farm products—clear evidence of a rise in economic productivity. The output of coal, pig iron, and copper all more than doubled and that of lead multiplied sixfold.


Manufacturing shared in the expansion. The Census reported 33 per cent more wage earners engaged in manufacturing in 1879 than in 1869, though 1879 was a year containing a cyclical trough and one following an unusually long contraction, while 1869 was a year containing a cyclical peak. An index of basic production compiled by Warren and Pearson nearly doubled from 1867 to 1879.


The rapid progress of the United States in manufacturing was clearly reflected in international trade statistics. Despite a decline in prices, exports of finished manufactures were nearly 2.5 times as large in gold values and 1.75 times as large in greenback values in 1879 as in 1867.

Based on the chart alone, it is clear that 1879 America was superior to 1869 America. There was a robust increase in the value of the national product, both in absolute terms and per capita. This is despite the population increasing by 25% in a 10 year period. The money velocity, which is used as a proxy for investment and spending, remained about the same, showing that money flowed around the economy with no problem.

The quoted passage from Friedman and Schwartz provides more detail, describing the manner in which vastly improved productivity led to more product at a lower price, which is the mechanism through which economic growth is passed to the masses on the whole.

The following chart is a more visual representation of what happened over that 10 year period, and is particularly instructive with respect to the overall point made about downturns and recoveries:


The following description accompanies the chart:

Consider the velocity series on that chart. Velocity declines from 1869 to 1871, rises to 1873, and declines to 1875. So far, so good. June 1869 marked a cyclical peak, December 1870, a cyclical trough, and October 1873, a cyclical peak, so these movements conform to the cycle in the same direction as later movements. But then comes a serious discrepancy. Velocity rose some 17 per cent from 1875 to 1879, bringing the terminal velocity to a level 4 per cent higher than in 1869 and 8 per cent higher than in 1873, both cyclical peak years.

The relevant detail is the fact that while velocity fell in the initial portion of the depression, from 1873-1875, it quickly responded over the next four years to reach a high surpassing the prior peak years. This puts the lie to the deflationary spiral fears propagated by central banks and their ideological brethren, given that the price level declined during this period. Indeed, the lower price level induced spending and investment, which is evidenced by the increased national product in 1879 versus 10 years prior.

The only evidence that this period was some sort of devastating time in American history was the protracted decline in prices, which was a constant of the time. And it is only considered a negative because of contemporary misunderstanding of deflation and inflation. Even in Friedman and Schwartz’ writing, they describe the idea as money velocity responding positively to falling prices as ‘a serious discrepancy.’

The Keynesian influenced economic dogma suggests that as prices fall, humans are more inclined to hoard their money as opposed to spending it because of the anticipation that an even better deal awaits them. In reality, these decisions are governed by an individual time preference. We as humans ultimately desire goods and services, not money for its own sake. Thus a certain level of ‘natural demand’ exists, which is discovered as prices fall, shifting preferences to preferring goods versus money. It is the falling price that persuades the change of preference.

Friedman and Schwartz’ astonishment at their findings is captured in the following, emphasis mine:

…an unusually rapid rise in output converted an unusually slow rate of rise in the stock of money into a rapid decline in prices. We have dwelt on this result and sought to buttress it by a variety of evidence, because it runs directly counter both to qualitative comment on the period and to some of the most strongly held current views of economists about the relation between changes in prices and in economic activity.


…In the greenback episode, a deflation of 50 per cent took place over the course of the decade and a half after 1865. Not only did it not produce stagnation; on the contrary, it was accompanied and produced by a rapid rate of rise in real income. The chain of influence ran from expansion of output to price decline.

Modern recessions are different, in that central bankers believe that once the price level rises again, economic growth will follow. This hyper focus on the price level is backwards thinking, mainly because prices are the effects of real economic conditions, as opposed to the causes of them. Furthermore, the modern economy employs a debt based consumer spending model as its means to economic growth.

This method is particularly prone to stalling, because the impetus for spending (increasing levels of debt) cannot continue in perpetuity. At some point, markets can’t support prices at the high levels producers need to set, which in turn leads to prices falling, profits falling, trouble servicing debts, liquidations, and layoffs. Yet, the solution presented by mainstream economics is to guide prices higher again. Here’s Nobel Prize winning economist Paul Krugman, writing in reference to the recent machinations over the Federal Reserve raising interest rates:

So the Fed should not be eager to raise rates until inflation and wage growth are at least at, and preferably above, where they were before the bottom fell out.

Krugman, like most in the mainstream, do not fathom that the bottom fell out precisely because prices were already elevated beyond what the market could support in the first place.


A Rock and A Hard Place


The debt-driven, consumer spending method of achieving economic growth which has been employed in modern business cycles has ended up being wholly inadequate; this is proven by the fact that the result of it was the Great Recession. This model of economic growth ‘worked’ as long as debt continued to expand. As long as low interest rates enabled producers to borrow to increase output at elevated prices, and as long as consumers could borrow to pay further elevated prices for final goods, things ran smoothly. Asset prices rose on the back of all of this, which enabled further borrowing, as the rising valuations of assets provided more collateral.

This all came to a head when the debt machine came to a halt. As mentioned before, since incomes are finite at any given time, there is a limit to how much can be borrowed. Once that limit is hit, the impetus to spending, by consumers and producers alike, is no longer there. That removed impetus set in motion the slowdown leading to the Great Recession.

The Federal Reserve, the ECB, the Bank of Japan, Bank of England and the rest of the major central banks responded to the Great Recession in an unprecedented manner. In lowering the rate of interest to zero and creating trillions of dollars from nothing to buy trillions worth of bad debt and government bonds, the price level in major economies was prevented from falling further. The debt engine was restarted; assets stopped falling and summarily went higher – for a time.

The story differs depending on which constituency you are in, but the gist is that the central bankers have only been able to succeed in spurts. That is they are able to engineer prices higher, as evidenced by rising inflation, but as time goes on prices stop rising. They must then spring into action again in order to kick start inflation, or at the very least prevent deflation. This is behind the ECB’s decision on Thursday to further loosen its monetary policy.

It is a former central banker, Richard Fisher, who perhaps unintentionally, but entirely accurately, described the nature of the mission central bankers have undertaken. In speaking with CNBC last Wednesday, he described the actions of the Federal Reserve since the Great Recession as injecting cocaine and heroin into the system, which is now being maintained with Ritalin. Fisher went on to say the following:

It was a discussion about the cost-benefits of QE, and the major objective was to create a wealth effect. So we drove rates to zero, we actually drove rates to the lowest yields in 239 years of history. When you do that, what you do is you change the way you discount future yields and future earnings. The market took off the first week of March 2009 when we made it very clear, we had already doubled the size of our balance sheet, and we were gonna do more. And that was the trip wire, or at least the ignition of this great rally.

Even more instructive, towards the end of the exchange, CNBC anchor Simon Hobbes asked Fisher that, having created the wealth effect, was it imperative for the central bank to ‘protect the market,’ and to underwrite it so as to prevent the economy from suffering if and when financial markets decline. Fisher answered that it would be a ‘reckless thing to do.’

Unfortunately for central bankers, this sort of recklessness is the only option open to them. In holding deflation as an iron clad negative thing, central bankers have locked themselves into a position in which they are compelled to force prices higher no matter what. This involves printing money to expand its balance sheet as Fisher mentioned.

These printing exercises are not singular events. Prices naturally rise and fall, so if you have sworn to eliminate prices falling, you are always going to have to be on the job, because at some point down the road economic fundamentals necessitate a decline in prices. It is then you will have to print again, which in the short run boosts prices once more…until the next time.

The drug analogy brought up by Fisher is apt. In injecting large amounts of liquidity to the system, the Fed was effectively shooting up with cocaine and heroin. The ‘high’ of that drug took the form of increased asset prices, increased investment and consumption, and so forth.

Like drug use, the high doesn’t last forever. It dissipates, and whatever reality the drug user was trying to escape returns. Similarly, when the effect of one monetary loosening campaign wore off, the threats to the economy that originally plagued it resurface. The unsustainable debt burdens, rather than being cleared, remain. The inefficient companies which should have been liquidated also remain, and so forth.

The drug user can keep taking more hits of the drug, but eventually, the body will become acclimated to that dosage of the drug, and the desired high won’t be achieved. It takes larger and larger doses of the drug to achieve a high strong enough to escape reality. Since the drug is a poison, there is some amount of the drug which will prove too much for the body to handle, and it will succumb to an overdose.

The economic equivalent of this is the specter of hyperinflation. In order to maintain the ‘wealth effect,’ which entails ever rising levels of debt, rising asset prices, investment and production, central bankers will have to provide ever greater amounts of liquidity. This explains why there have been three Quantitative Easing programs in the United States, of increasing size and duration. Every time a QE program had been stopped, the economy subsequently threatened to roll back into a deep recession.

Maintaining the economy on Ritalin won’t work, it needs something much stronger. Yet, doing so will endanger the very viability of the dollar. No one knows exactly where the breaking point is, but it does exist. There is a point at which the US dollar will become worthless, as long as the Federal Reserve fashions to print its way out of recessions.

As such, the Fed is truly between a rock and a hard place. It cannot explicitly underwrite expansion of debt in perpetuity without destroying the dollar. On the other, it cannot stop the expansion of debt without destroying the impetus for appreciating prices, and therefore the recovery it engineered. The Fed, as well as all central banks, must choose between their (flawed) notions of engineering economic growth through debt based consumption, and the currency. Only one can survive.




Of course, central bankers can easily hop out of the box they’ve placed themselves in, but it requires them to change their thinking. It requires them to forget the notion that increases in asset prices can only be positive, regardless of the reason why the asset prices are rising. It is the same craving for an instant, better high which dooms the drug abuser. As drug users need not try to escape from the lows of life via the highs of drugs, central bankers need not attempt to escape the temporary blips in human progress – recessions – via the exuberance of stock market manias, tech booms and housing bubbles.

At the risk of sounding inhumane, the patient who ended up in the ER at the depths of the Great Recession wasn’t worth saving.  Having said that, a more accurate medical analogy one can use is a cancer diagnosis. The Great Recession was the emergence of a large tumor which was threatening our well-being. After being diagnosed, the doctor told us we had two options: Undergo severe chemotherapy and radiation that might leave us bedridden for up to 18 months to two years, followed by a few more months of physical therapy. After that, the cancer would be completely gone. The other option would be to take a daily cocktail of medication, mostly to numb the physical pain and other symptoms of the tumor. We could physically go about our day as normal, but the tumor would remain, slowly entrenching itself in the body.

The latter option was chosen, as QE, TARP, and other programs constituted the cocktail of medication which numbed the pain and restarted the engine of growth from the prior cycle. Asset prices rebounded, job growth returned, and the economy looked to be on solid footing again.

However, the tumor is still with us, and thriving even. The ‘medication’ given to us by the Federal Reserve has meant that all sectors of the economy, from household to business to government, are now more saturated with debt than ever before. From the perspective of such a levered lot, the mere interest rate increase of 0.25%, let alone a proper normalization, borders on usurious. The fundamental truth remains that an economy which must have constant price increases to grow is an economy that will be prone to sudden, severe crashes as the general consumer base does not increase its income and take on debt at a fast enough pace to sustain demand at higher price levels.