INSIGHTS: FALSE READING: THE FED’S EQUITIES LIGHT IS “GREEN” BE THE ECONOMY IS CRASHING
Guest Columnists: Charles Hugh Smith, author and Founder of the Of Two Minds blog, ranked #7 on CNBC’s alternative financial blogs.
Sadly, as markets stall and crash, participants will still be in their seats thinking all is well.
The tragic 2009 crash of Air France Flight 447 offers an apt analogy for the global economy and central bank-driven false signals. Flight 447 entered an area of frigid turbulence over the Atlantic which caused the air-speed sensors (pitot tubes) to ice up. A few minutes later, the autopilot disengaged, and the co-pilot flying the aircraft over-corrected in the turbulence.
Deprived of accurate airspeed readings, the co-pilot misjudged the situation and attempted to climb, causing the aircraft to stall. Unable to recover, it crashed into the Atlantic, killing all on board.
The co-pilot’s last recorded words are haunting: “We’re going to crash! This can’t be true. But what’s happening?”
The Federal Reserve’s massive pimping of the stock market has frozen free-market feedback, generating wildly inaccurate readings which are leading participants to their doom. Stripped of price discovery and accurate readings of risk, participants are attempting to recover recent highs, a misreading of reality that will cause the stock market to stall and crash.
In effect, the Fed is jamming the equities market light on”green” when it should be flashing red and a stall alarm should be sounding. Participants in the current manic rally are looking at the indicator light–a steady green, indicating A-OK–when in reality the global economy has stalled out and is crashing.
Thanks to the Fed’s pimping, the indicators no longer reflect the realities of price discovery or risk, and so participants are making a fatal error: they are assuming that the indicator light is accurate and that the stock market is “safe” and “stable,” when in fact it is unstable and stalling.
Having inflated a high-risk, unsustainable bubble from September 2019 to February 2020, the Fed’s response to the stock market stall in March has been to create false readings of stability, risk and altitude. While punters and money managers are acting on the panel of green lights (“The Fed has our backs, stocks will rise, there’s no risk”), the market is actually stalling out so severely that the warning sensors have shut down.
Sadly, as markets stall and crash, participants will still be in their seats thinking all is well because the Fed has jury-rigged all the readings to be bright green and disabled the stall alarm.
ON THE ECONOMY: FREE FALLIN’
John Dunham, Managing Partner, John Dunham & Associates
She’s a good girl, loves her mamma. Loves Jesus and America, too. She’s a good girl, crazy ‘bout Elvis. Loves horses and her boyfriend too, yeah yeah. It’s a long day, livin’ in Reseda, there’s a freeway running through the yard. I’m a bad boy ’cause I don’t even miss her. I’m a bad boy for breaking her heart, and I’m free – free fallin’, fallin’. And I’m free – free fallin’, fallin’. The late great Tom Petty is not the only one free fallin’ right now. In fact, the entire world economy is in the midst of a massive depression that some have termed the Great Suppression. Of course, in the Fall of 1989, when Petty released this song that he wrote along with Jeff Lynne, the economy was growing at a rate of about 3.9 percent. Today the projected GDP growth rate for the 2nd quarter of 2020, is somewhere around -33.3 percent according to the Conference Board.
This is a massive contraction and is larger than any in US history. At its worst, in 1932, the economy during the Great Depression contracted at an annual rate of 13.5 percent. Were this the result of the COVID-19 influenza virus it would be bad enough, but in reality, the coming depression, like the Great Depression of the 1930s is self-imposed and has been brought about solely due to bad political decisions and policies.
Of course, this should not be taken to mean that the COVID-19 virus is not highly contagious, nor does it mean that it could be deadly to some individuals. What it does suggest, however, is that there are always alternative ways to deal with any situation, and in this case, the consequences of the reaction will almost certainly be worse than the consequences of the virus itself.
Market economies naturally go through cycles, and recessions are important in keeping the capitalist system functioning. Simply put, a market economy works only when goods and services are constantly produced and consumed, and normal recessions occur when too many producers (or investors) make the wrong bet on the wrong horse. By reallocating resources from bad investments to better ones, recessions are like bottom feeding fish, in that they keep the economic river clean.
Depressions, on the other hand, are almost always caused by political decisions gone bad. That does not mean that these political decisions are always wrong or even necessary, but it does mean that they had consequences that led the machinery of the market to break down.
There have been 18 years during which the size of the US economy fell by 3.0 percent or more. Of these, 6 directly followed a major war. War is a political decision, and while war might sometimes be necessary, it is never good for the economy. Of the rest, nearly all were initially brought on by normal economic cycles but were made worse by government action. In 1884, and during the Great Depression, the government tightened credit just when liquidity was most needed helping to extend and deepen normal cycles. Restrictive trade policies also helped make the Great Depression, well Great. The same was true in 1937, just as the economy was recovering from the Depression, the Roosevelt Administration reacted to higher inflation by freezing the money supply. With access to capital constrained, the economy tanked and did not recover again until June of the following year.
Both the 1908 and 2008 recessions were brought about directly by government policies. The first, was the result of the sudden implementation of Progressive policies, notably price controls, that led to a collapse of the railroads (the Internet of their time), while the 2008 recession was caused by uncontrolled lending for residential real estate that was encouraged by government policies to increase home ownership, and then lengthened first by a panicked response by the Bush Administration to rescue mal-investments that should have been allowed to quickly fail, and later by a massive increase in anti-business regulations by the Obama Administration. In fact, the 2008 recession in many ways never ended, as economic growth during the following 10-year stretch was driven almost solely by increased borrowing.
The country’s worst recession outside of the Great Depression occurred in the 1890’s, when a plethora of economic black swans descended on the world at one time. These swans ranged from wars to major technological developments (for example the adoption of electricity). This was also a period of massive expansion of the monetary base, and with that inflation. This was, however, more of an indirect player. Government policy was more a neutral player during this difficult economic downturn.
In two cases, government intervention actually made things better. In 1914, the world economy crashed as Europe prepared for war. A financial panic ensued and investors sold assets in bulk to generate cash. Much like in 2008, the world financial system seized up and for six weeks during August and early September every stock exchange in the world was closed. In response, the Treasury Department used the emergency powers to allow banks to issue additional bank notes, increasing the money supply. More importantly, the US stayed true to the gold standard, which helped increase confidence in the overall economy. In 1921, President Harding reacted to a downturn by slashing taxes, and cutting government spending in half, freeing capital for private markets. In both of these cases, the economy went through a normal business cycle and recovered quickly.
On net, government policies have led to or worsened the vast majority of the major economic downturns experienced by the country over its history. Of course, some of these political decisions were necessary, in fact essential, but in at least five cases, bad government decisions were the culprit.
This is an important lesson to remember during the current crisis, The Great Suppression. In this case, governments throughout the world have reacted to the outbreak of a virus with what can only be described as a giant hammer, in many cases literally shutting down the market itself. This decision was taken with very little, if any thought to the economic consequences, which now include vast millions of unemployed workers, the inevitable bankruptcy of thousands of firms, a massive erosion in tax revenues, and a staggering increase in Federal debt.
These are all real consequences of the reaction taken to control the spread of the COVID-19 virus. They were consequences that were well known to decision makers when they shut down major parts of the economy. It may have been a good decision, but it was made at a time when the actual effects of the virus were basically unknown. There were other ways that the spread of the virus could have been reduced that did not involve pulling the economic emergency break, and it will be some time – if ever – for us to know if they were even considered.
Panic policymaking, implementing decisions before examining alternatives, and even worse, sticking with a decision after one has been proven wrong, are all things that elected officials often do. Fortunately, the economy can generally weather the storm brought on by poor decisions, however, it’s hard to think about recovery when you are free – free fallin’.