The Hypothesis That Investors Are Missing

‘Déjà vu’ is a French expression that means… well, you know what it means.

For our purposes, we will use it to refer to the slumpy economy… and to the feds’ response. We’ve see it all before.

‘Dans la merde’ is another French expression… which refers to where you end up when the feds’ undertake to fix it.

But the Dow shot up 217 points on Friday. Gold went up $18. How to explain it?

With Europe on the brink of a blow-up (where it’s been for years)… China’s economy slowing down dangerously… and much of the rest of the world already in recession you’d expect investors would think twice before buying more stocks. After all, what are stocks? They’re shares in real businesses. When those businesses do well, the shareholders should do well. But businesses don’t usually do well in a recession.

Investors, however, seem to be following a different line of thinking. They are responding to two entirely different hypotheses.

  1. The economy is doing well. That was the news in the latest unemployment report. Therefore it makes sense to own stocks and gold. As the economy improves, more people will borrow and spend. As they do so, interest rates and consumer prices will rise. Businesses will do better as their sales rise. Higher inflation rates will cause gold to go up, too.
  2. The economy is not doing well. And the worse it does the more pressure builds on central bankers to ‘do something’. What can they do? Only add more cash and credit. More liquidity will send both stocks and gold up.

Now, you will look at these two hypotheses and think you have discovered a sure thing, no? A ‘can’t-lose’ proposition, right? Either the economy is doing well. Or it isn’t. Either way, stocks are going up! Win… win… right?


How about a third hypothesis? In this one, the whole world is sliding into recession. Britain and Europe are already there. Japan is almost there. The US is trailing, but not by much.

Recession is what should happen. The developed economies are still in a Great Correction. And the effects of massive doses of new credit… cheaper money… and a big increase in the world’s money supply (central bank assets have doubled since ’08)… are wearing off. Once again, the private sector is trying to correct its mistakes – shucking off bad debt however it can. People are being more careful with their money – which is why sales fall and unemployment rises.

Nothing new about this either.

And nothing really new about the feds’ reaction. Murray Rothbard described the feds’ response after the crash of ’29:

“If the Federal Reserve had an inflationist attitude during the boom, it was just as ready to try to cure the depression by inflating further. It stepped in immediately to expand credit and bolster shaky financial positions. In an act unprecedented in its history [but repeated after ’08] the Federal Reserve moved in during the week of the crash… the final week of October… and in that brief period added almost $300 million to the reserves of the nation’s banks. During that week the Federal Reserve doubled its holding of government securities…”

Then, as now, the big increase in money supply produced something that looked like a recovery. Rothbard continues:

“By mid-November, the great stock break was over, and the market, falsely stimulated by artificial credit, began to move upwards again.”

In our current episode, stocks have recovered from their ’08-’09 crash. Banks, teetering on the brink of collapse, were saved too – as the feds let it be known that they would do ‘whatever it takes’ to spare them from the consequences of their own mistakes.

And the leaders of the rescue, mainly Ben Bernanke himself, are hailed as heroes… having saved civilisation. The 1930s had its heroes too. The first was Mr Herbert Hoover, who had engineered rescue efforts following the Great Crash. Rothbard:

“President Hoover was proud of his experiment in cheap money and in his speech to the business conference on December 5, he hailed the nation’s good fortune in possessing the splendid Federal Reserve System, which had succeeded in saving shaky banks, had restored confidence, and had made capital more abundant by reducing interest rates.”

We know, however, that heroes of the ’30s had not really saved the financial system from a day of reckoning; they merely postponed it… and stretched it out.

The crash and depression of ’20-’21 was more severe than the current crisis, but it was over within 24 months, during which time the feds made no rescue attempts. The washout after October 1929 probably would have been a short and violent one too. Instead, the feds came to the rescue and turned it into a 20-year period which included a Great Depression and WWII.

That’s our third hypothesis: déjà vu all over again, with more intervention, but no real recovery. Instead, the day of reckoning will be pushed into the future… and the whole correction process will be turned into a long, painful episode of little growth, high unemployment and periodic financial crises.

And here’s an additional forecast: Ben Bernanke will not want to re-live the ’30s. He will not want that déjà-vu experience. When the US economy is ‘dans la merde,’ he will give it more cash and credit… so that it is even further ‘dans la merde!’


Bill Bonner
for Markets and Money

From the Archives…

As Draghi Drags the European Crisis On
03-08-2012 – Nick Hubble

China’s Economy – How the Devil is in the Detail
02-08-2012 – Greg Canavan

The Greatest Interest Rate Fix featuring… Mario Draghi and Friends
01-08-2012 – Bill Bonner

What the Credit Boom Left Behind
31-07-2012 – Greg Canavan

The Australian Economy: A Case Study in Weirdness
30-07-2012 – Greg Canavan

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail Markets and Money.
Bill Bonner

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