The WSJ has an interesting opinion piece this morning that should be required reading — but it won’t be by far too many of the political wonks.
In a 1996 speech to the American Enterprise Institute, Federal Reserve Chairman Alan Greenspan famously warned about the dangers when “irrational exuberance” fueled asset inflation. By that he meant that rising values of stocks and real estate might reflect only a cheapened dollar, not an increase in their real worth. Since he was the man in charge of the dollar, his remark caused quite a stir.
We’ve learned a lot about asset inflation since that speech, but maybe not enough. The nearly 2,000-point rise in the Dow Jones Industrial Average since last June no doubt at least partly reflects asset inflation, since there has been very little in the economic or political outlook to justify it.
Actually, we’ve learned exactly nothing, save one point — politicians love asset inflation, and the more they can stoke it the more they love it.
The reason is simple — it gives them something to point to as a so-called “measure” of economic health, they get to tax it, and it is something they can twist knobs on in the monetary and fiscal policy realm to pretty-much dial up — most of the time.
This leads political sorts — and central bankers — to deduce that such is “free.”
But nothing is ever free.
Unbacked credit issuance is exactly identical to currency printing in economic terms. And our history since the 1980s has, unfortunately, been to abuse monetary and credit systems as a means of covering up our desire to borrow and spend more and more to keep up the chimera of so-called “economic growth.”
This isn’t a “new” problem; our economy in the United States has put on roughly 3% in new credit above the rate of GDP growth since records became reasonable-available in enough detail to analyze — which dates to the 1950s.
Now take a look at this graph (again):
That’s the credit and GDP expansion quarter-by-quarter. The modeling of it in terms of levels (as opposed to flows) is roughly this:
For those who think this isn’t what our debt picture looks like in the above, uh, well…
Now notice that since 2009 the pattern has changed. That is, while we have fits and starts of credit creation net-net, we can no longer maintain it. The markets are at present responding to what they believe is the old paradigm — but that paradigm no longer exists.
Instead, what is happening is that as the Federal Government becomes the only issuer of this new credit (and the Fed the only market sink) the impact shows up in reduced purchasing power that disproportionately falls on the lower and middle classes, since the economy in general refuses to “lever up” — because the people either can’t or won’t.
The consequence of this is not hard to figure out.
If you have 1,000 units of production and 1,000 units of credit or currency with which to buy that production, and you then emit another 1,000 units of credit into the system, the price of something will rise. By bringing this pressure on market prices artificially you will spur people to produce more. This is what all the politicians and monetary wonks claim is a “virtuous cycle”, but they’re wrong, because the demand that led to the increased output is not real.
If this was a one-time shot it might be defensible, but it can’t be due to the fact that the borrowed funds have to be paid back. This in turn leads you to demand $X + 1 in “stimulus” next, because the “+1” is necessary to cover the carrying costs on your original $X borrowing.
This is the trap into which Japan fell. Now they’re trying to “force” inflation, when the natural economic state is a mild deflation — exactly as they have had!
They can force inflation but in doing so they will destroy the purchasing power of their lower and middle classes, which eventually will lead to the collapse of their society and government.
This is exactly the policy being propounded here in the United States, and in fact the policy being run since 2008. Barack Obama, with the full complicity and in fact cooperation of Congress, including the Republican House, have pursued the mathematically certain bankrupt strategy of deficit spending as a means to “reflate” the economy.
But while the stock market is close to its previous highs real purchasing power of the lower and middle classes, along with the labor force participation rate, is worse today than it was in 1980 and the rate of deterioration is accelerating!
There is no way out of this box without acceptance of the adjustment that must be taken in the economy as a whole, and the longer we continue to play the game of subsidy and handout, which is really nothing more than reaching into one pocket, withdrawing two $20s, putting one into the other pocket while the other on fire and then claiming to be $20 richer, the worse our outcomes in the economy and society will be.
No serious discussion or debate about the budget can take place without the removal of these cross-subsidy effects, and nowhere are they more serious than in the stock market and health care sector. Those two areas, particularly the latter, must be addressed.
But as of right now they’re not even under discussion while we are but one small economic incident away from triggering the next major downturn — with no policy tools remaining to address it.
That incident is coming and is likely to be as simple as market recognition that the driver of asset inflation through the last 30 years is no longer present and cannot be restarted, despite claims to the contrary that it’s “just around the corner.”
When that recognition hits the markets — and it will — look out.