You already know our major hypothesis.
It’s ‘inflate or die’.
Once an economy has gotten used to big doses of cheap money (artificially low interest rates…deficits…quantitative easing, etc.), trying to go back to normal monetary policies is painful. It’s like a man who has gotten immensely fat by eating 10 cream pies a day. Cut down on the pies, and he’ll need a new pair of pants.
So too will an economy. Yesterday came more news that the US economy is shrinking. The Wall Street Journal reports: ‘U.S. Economy Shrank Last Quarter’:
‘The U.S. economy shrank for a second quarter in a row—a common definition of recession—as businesses trimmed their inventories, the housing market buckled under rising interest rates, and high inflation took steam out of consumer spending.’
High calorie fiat diet
There’s some immutable law of the universe that tells us that overdoing it brings unhappy consequences. Cream pies cause problems — diabetes, high blood pressure, and, of course, obesity itself. So, too, did the Fed’s high-calorie credit diet inevitably led to the doctor’s office.
‘Too much’, came the diagnosis. ‘Cut back’, came the prescription.
And so it came to pass, after creating the problem itself, denying there was a problem…and then insisting that it would pass on its own, that the Fed began a campaign to moderate its intake of cream pies. On Wednesday, it took another 0.75% slice off the table.
It’s either more or less. Fat or slim. Inflate or die.
But what we are wondering about today is the space in between. Does the Bubble Epoch have to die completely? Couldn’t it be just a little dead?
Suppose the economy were to shilly-shally around…neither expanding nor contracting…indefinitely? And couldn’t stocks resume the course they have taken for the last 40 years — dipping now and then but recovering upward momentum? Why can’t Apple become a US$5 trillion corporation?
Since the Fed began its diet program, stocks lost as much as 20% of their weight. Bonds slimmed down. Mortgage refinancers cinched up their belts. Recently, commodities and energy fell too.
Maybe that’s enough?
Investors were jubilant this week. They think inflation may have ‘peaked.’ After all, didn’t inflation come from Putin’s war…supply chain disruptions…and stimmy cheques? And aren’t those things all, well, transitory? And isn’t the inflation they caused working its way through the system? Like a bad meal, it will soon be gone.
And then, the Fed will not need any more 0.75% rate hikes. Instead, it can begin to ease off. The damage from higher mortgage rates…and higher lending rates generally…will be contained.
We are just reciting what we believe to be the main line of talk on Wall Street. We don’t believe it ourselves. Because the cream pie-eating fatso analogy quickly breaks down. A man may slim down a little or a lot. If he does, he doesn’t have to remodel his bathroom, get remarried, or order a new dining room chair. Life goes on, much as it did before.
But when the Fed decides to ‘slim down’ the economy…the pie store goes belly up! Debtors can’t repay their loans…so their creditors go broke. Businesses can’t afford to pay so many employees — so unemployment goes up. Stocks, bonds, and cryptos — that looked like big winners just six months ago — are suddenly revealed as Ponzi schemes, doomed from the very get-go.
In a healthy economy, people barely notice the Fed. Its manipulations are slight. Its errors are small. It stays out of the way.
That’s the way it was until the 1990s, when Alan Greenspan began backstopping Wall Street. Later, after the mortgage crisis of 2008, the Fed intervened on a scale never seen in the US. Interest rates were pushed down to near zero…and left there for more than 10 years. In a single month in 2020, the Fed added more new money than had been ‘printed’ in the preceding 100 years. And now, the whole economy has an almost insatiable appetite for more credit from the Fed.
It’s a monster. Either inflate it. Or kill it.
But why does it have to die? Couldn’t it be just a little more normal? A little less obese? Couldn’t it die just a little bit? And then, come back to life?
Hmmm…we’ll have to think about that…
For The Daily Reckoning Australia