Last Thursday, the Dow shot up 421 points, following a US Federal Resreve announcement that it will be ‘patient’ about normalizing interest rates. No one knows what was in this package, probably not even the Fed itself, but speculators thought it had a ribbon and bow on it. On Friday, they drove the market up another 26 points.
But we have our doubts about Santa. Does he really exist? Or it is just a myth we tell children, mental defectives, and stock market investors?
After all, a stock is just a share in a business. Why would the business be more valuable simply because the Fed tells the world that it is in no hurry to stop torturing interest rates? We knew that already. And it shouldn’t improve the real worth of your business anyway. On the contrary, it will more likely depress the value of the business, because, the more the central banks distort key price signals, the more your business is prone to making bad investment decisions.
And so we begin the last installment in our series on the macro picture. Our view, as we’ve explained, is not the view taken by Janet Yellen or Paul Krugman. Ours is the minority opinion. No Nobel Prizes have yet been awarded to us and no central bank follows our recommendations. (Although, the German central banks seems favourably inclined…)
But that is not to say that our opinion comes out of nowhere. Not at all. It is based on hundreds of years of thinking by classical and ‘Austrian school’ economists. It is also supported by both experience and intuition. For example, at its foundation are core principles that have never been disproven. ‘You can’t get something for nothing,’ is just one of them.
‘A penny saved is a penny earned,’ is another.
Most modern economists don’t believe either of these two things — at least, not when applied to a whole economy. Remember how we were careful to understand what money really is? It must have something real behind it…real savings, real work, real resources… or it is not worth the paper it is printed on. It is no more than counterfeit money. And yet, when the Fed engages in ‘quantitative easing’, in which it buys assets with money created specifically for that purpose, it tries to get something for nothing. The Fed has no real savings or real money. Its ‘money’ is created like that of a counterfeiter. And it is just as valuable! It passed throughout the economy just like real money.
Most central bankers (and most economists, for that matter) also believe in the ‘paradox of saving’. Saving money may be good for an individual, they say, but it is bad for a whole economy. The more people save, the less they spend; the less they spend, the less consumer-led, demand-driven growth. Nonsense! There is no paradox. Saving is good…for individuals and groups. Economies do not become wealthier by spending; they become wealthier by saving. It is the process of saving…and investing in productive capital goods that makes spending possible. Not the other way around. The more saving, the more capital the society has, which it can use to increase output and become richer. Then it can spend.
You might wonder why so many modern economists believe things that are so obviously untrue. The reason is probably because it is simply man’s nature to want to control things — even when control yields negative results. The ‘modern’ economist offers to manage the economy…to rescue it from its occasional crises…and to improve overall output by moderating cyclical downturns. In return for pretending to do so, he earns status, compensation, professional prizes, columns in major newspapers…and from time to time, he even gets his photo on the cover of TIME magazine.
What actually happens as a result of his meddling, though, can be studied by taking a quick look at today’s energy industry. The Fed’s ultra-low rates signalled to producers that capital was plentiful and cheap. So, why not use it to produce oil? By now, the pumpers have borrowed about $500 billion and are using the money to drill holes all over the place. They hired people too — one figure we saw suggested that almost all the new jobs in the US created since ‘08 were related to the energy boom. Then, commentators began to talk about the new oil boom…and how it would cause a whole industrial renaissance in America. With cheaper energy costs, a thousand commercial flowers were supposed to bloom.
What happened? The flowers wilted. The price of oil collapsed and this undermined the industry’s collateral. All of a sudden it looks like a lot of subprime energy debt is going bust. And that marks the end of the capital spending boom that has been a highlight of the whole ‘recovery’ folk tale.
But look what else happens when first you practice to deceive. News reports tell us that consumers have changed their buying habits.
‘I’m buying gas at $1.99 a gallon,’ said one of our sisters, who drove up from Charlottesville, Virginia, for a family reunion.
‘I haven’t seen it that cheap,’ said another. ‘But it’s just a little over $2. And you really notice it at the pump. I decided to use the savings to buy the family a new television.’
Our sister wasn’t alone. News reports tell us that consumers are adjusting to a lower price of oil. Many people are buying large gas-guzzling new automobiles again. Others are cutting back on home insulating, solar panels and other energy-saving measures.
Oh what a tangled web Mr Fed has woven! The whole fabric of modern society has been changed thanks to his clever guidance.
But wait…what if the price of oil goes back up? What if the price — like the stock market — only went down because the market was manipulated? What if the oil price were only lower for a bad reason — because the price of capital had been pushed down artificially by the central bank?
If that is so, you might expect oil to go back up before long. By then, many producers will have been put out of business by the artificially low price. And many consumers will have been lured by the low prices into a position where they are vulnerable to higher prices. Central bankers will have damaged both the producers and consumers.
Since 1987, central banks — led by the US Fed — have pumped up one bubble after another. The Final Bubble…the big kahuna of a bubble, in credit itself…is still expanding. If our macro analysis is correct, central banks will continue inflating this bubble as long as they can. Then, it will blow up.
Of course, we have no way of knowing whether we will be right or wrong. Still, investors should be wary of performance claims based on the last 30 years of experience; these years saw a huge increase in credit. They should also distrust any projection of future performance based on those years.
Finally, they should be on guard. They don’t want to be caught unawares and unprepared if it turns out that we were right and the credit bubble finally explodes.
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