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8/17/15Living the Lie of Prosperity in America
Note: this was written one week before the market crash in August.
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It’s been a hot, sweaty, disgusting summer, and I’m not talking about the weather. I'm talking about the economy.
And if economic signs of late are any indication, I can be pretty sure that this iConomy, currently propped up by the self-proclaimed market gods of the Federal Reserve, speculators, and hapless consumers, will begin cooling down for the foreseeable future. One thing's for sure... things are about to get a bit more interesting.
Why do I think things have been “hot?” I pulled up a chart this morning for some market perspective: Check this out:
This is what an overheated market would look like: the arrow indicates that since the most recent market bottom in 2009, equities (stocks) have seen parabolic growth, despite there being no significant change in economic conditions such as wage growth, real company earnings, and real unemployment.
Can your body grow if it isn’t eating enough protein or solid food? No. And an economy, which functions according to natural laws, is no different.
The only explanation is that the market is on steroids. What kind of steroids could possibly cause the stock market to get buffed up?
It’s called Quantitative Easing. Maybe you’ve heard of it? Monetary intervention by the Federal Reserve Bank of the United States.
After the recession, the Fed gradually came to the toxic Keynesian conclusion that it could force economic growth by pumping an enormous amount of money (using government debt) into the US economy. Here’s how this works.
Individuals want their money safe, so they take it to a bank for safekeeping. The bank can then lend out that money to individuals or businesses to make a profit by earning interest. But the bank is limited by federal regulations in how much of its reserves (cash on hand) it can lend out. So, sometimes it takes “overnight” loans from the Fed to provide it with additional funds to meet these regulations, and the Fed charges the bank a rate, the "overnight rate." The Fed gets the money it lends by selling government bonds to investors and individuals in exchange for the promise of a rate of return.
The lower the overnight rate is, the more a bank is encouraged to borrow, since the more it borrows, the more it can turn around and lend, and the more money it can make in interest.
Businesses, for the most part, are smart about not borrowing too much—or if they do borrow, they make wise choices about allocating the money. They borrow what they need to in order to expand or make additional profits. Individuals? Not so much. They mostly borrow to buy crap like cars, boats, and houses they can’t really afford.
As it happens, during the last six years or so since rates have been so low, many businesses borrowed a lot of money—especially institutions which could put the cheap loans to good use in things which were set to explode in price—real estate, commodities, stocks, etc. Other companies, whose stock was trading at low prices, used the cheap loans to buy back outstanding shares of their own company, which resulted in higher earnings per share—this is called financial engineering, or as I like to call it in technical terms, “faked profits.”
In either case, the businesses were making money in smart ways, or at least appeared to be. The borrowed money was put into assets whose prices were going up, causing companies to make profits. This good performance in turn affected the company’s own stock price, because more investors wanted to pile into these companies which actually were, or appeared to be, doing very well financially.
This resulted in more cash on hand, for companies to use however they wanted. A virtuous cycle. The big companies, especially those in the financial industry, pumped trillions of dollars worth of borrowed funds into equities (stocks), and made a ton of money in the process. The heavy buying has resulted in the "hot" market I've been going on about.
Businesses Doing OK, Individuals Floundering
So here's a recap, in case you haven't been paying attention: Businesses have been making tons of money for half a decade now, due to low interest rates, while individual consumers, knowing little about money, just used low rates to buy new cars, or refinance their home loans to lower rates, so they could buy more stuff with debt, instead of investing the excess cash. This is why the middle class has benefited roughly ZERO from low interest rates (otherwise known as Zero Interest Rate Policy, or ZIRP), while the rich have just gotten richer. This happened because they were educated about financial matters.
This is the reason Bernie Sanders, presidential candidate, is demonizing business, and trying to buy your votes by making you think you are a victim in this whole plot.
But since we don't buy into all that socialist victimization crap, I'll point out the obvious: Big business hasn't done anything to the middle class. The middle class (ignorant, entitled, unsatisfied with life, etc) unwittingly screwed itself over by not being educated about money.
We're now coming to the close of this era. There’s a lot of talk these days about the period of low rates coming to an end. That brings us to where we are now: the end of summer, at the surreptitious end of a period of very low interest rates.
Speaking from a historical perspective, the summer period is usually the slowest time of the year for stocks and the market in general. Going back nearly seventy years, stocks have returned only 0.3% from the period of May through October. This has given rise to a popular and well-known phrase in the investing world, “Sell in May and go away.”
It’s not that the market always goes nowhere, or is flat during this period—rather, the opposite. Typically, stocks have a much higher volatility during these months—in other words, prices swing back and forth, from low, to high, and back down to low again. If you’re in a position where you’re buying and selling stocks frequently (I’m typically not, but there are some exceptions), these wide swings can cause you some headaches, worries, and setbacks as you suffer losses and hit trading stops, or predetermined points at which you have decided that you will sell an investment.
During the last few weeks, the stock market took a bit of a dump, just after nearing its all-time high. It actually turned negative for the year, meaning that if you bought your first share of a company’s stock on January 1st, and held it until now, you’d be losing money. This is not hugely significant, but it is important because it is a market gauge used by Wall Street and portfolio managers to judge their year-to-date performance. No one wants to tell their clients their investments have gone negative for the year.
A series of events led us to where the market is now. But the biggest of these events has yet to unfold— the elusive rate changes, and any collateral damage associated with that.
Sure, some things are behind us for now, or have been kicked down the road for someone else to deal with. The Greece situation in Europe has been resolved for now, and this should have been a good sign for the market. No more currency crises, right? No more talk about the collapse of the Eurozone?
Well, in my mind, Greece is the least of our worries. There are larger things at play.
Like the potential collapse of the dollar, for example. For the last few years, the US dollar has been on the brink of losing its status as the world’s reserve currency, as the world loses its faith in the US’s ability to lead economic growth. This is an event which would cause irreversible and detrimental changes to the entire world economy—and particularly, the way of life for 300 million Americans.
Every news story I read is worse than the next, and the evidence mounts that monetary intervention in the US has failed to produce any economic benefit. Democrats, who laud the performance of Obama as president, were told last year before the election to specifically avoid using the word “recovery”in speeches. This consensus alone is pretty much evidence that a recovery never existed.
Then there are articles like this one, which purports to prove that pretty much any sort of economic “growth” or “profits” made by companies this year has been not the result of actual growth, but financial engineering and cheap accounting tricks (I don’t blame the accountants, but the CEO’s, of course).
Then there’s this little bit about issues in the housing market, this one about auto manufacturing, and these about student loan bubbles and subprime auto loan bubbles which are about to pop. The US economy is slowing more than ever.
The one place we could once turn to be assured of hope of economic growth—China—is even letting us down. A decade ago, China’s economy was unstoppable. China was our last bastion of hope for something to be growing in the world economy. No—quantitative easing didn’t work there either despite all faithful efforts. And Europe has obviously not learned the lessons from the US, Chinese, or Japanese monetary interventions.
Economy and Markets Teetering on the Brink
With this last glimmer of hope having disappeared, there is nothing left to keep the economy turning in a significant way.
As our good friend, Komrade Obama, might say: LET ME BE CLEAR: these world events, which you have no idea, or couldn't care less about... they all affect the job market, the company you work for, the price of the hamburger you had for lunch, and yes—even your savings and retirement accounts. Every aspect of your financial life.
But most of you aren’t even paying attention to them. I think about them everyday, and they worry my horribly.
The situation in our economy has forced the world of investing to become a world of gamblers and speculators, whose every move has come to depend on what the Fed is doing—raising rates, lowering rates, pumping money into the economy in the form of US bond purchases, etc. No one even cares about balance sheets or income statements anymore, as they should.
The underlying problem with our financial system is that nothing in our economy has functioned naturally for almost a decade, when “stimulus” packages, bailouts, bail-ins, QE, low interest rates, and government “investment” began skewing the prices of commodities, financial assets, and balance sheets to the point where no one knows the true and natural price of anything anymore.
If the economy is ever again allowed to function naturally outside the grasp of the manipulative Federal Reserve, I believe a crisis will unfold which few now living have ever personally beheld.
A Great Deflation.
My biggest fear at this point is deflation. Call me crazy. Things could change, but that’s the only thing I see on the horizon.
Ever experienced deflation? I know I haven’t, but it freaking scares me. You’ve heard of the Great Depression, haven’t you? That was a tremendous period of deflation. The “Little” depression after the 2008 crisis was bad enough… read a few books, or watch the movie “The Grapes of Wrath”, and you’ll find that things can be much worse than they were during the mini recession we had a few years ago.
How bad would things be?
Remember all that talk of bank lending? Well, in deflation, nothing moves. Want to sell your car, or your house? Fat chance. Nobody will be buying or borrowing, because the available supply of money is diminished in the economy. This means decreased buying of cars, houses, real estate, investments… you name it.
Then of course, there's the massive unemployment, not to mention a severe lack of the basic necessities of life. Oh, and banks failing. You'll have trouble even withdrawing enough cash from your bank to cover your basic expenses. Think that can't happen? Look at Greece. And our debt crisis will be much worse than theirs.
Many sitting cozy in their office jobs, like me, may come to the tough realization that our services are no longer needed by our employers, because money isn’t flowing in or out of the place of business well enough. In a deflation, spending stops at the corporate and individual level, because both are broke. And if nothing is being bought (no demand, high supply), the price of everything drops.
People complaining now about joblessness, waiting for government to pass some sort of bill to raise their minimum wage, or for someone to rescue them from their crippling student loan debt, will wish they’d taken that job at McDonald’s when it still existed—when they still had enough money to splurge on that disgusting hamburger.
The one good fruit of deflation is price and profit normalization. Profits can’t be engineered if there are no slush funds. Every cent a company has is put to its absolute best use. The same will apply for households.This would actually be a very healthy and positive thing for the economy. The nature and depth of the crisis would be such that true price discovery would emerge once again in the markets for all assets and commodities.
When all this happens, will you be wallowing in sorrow, buying into the lie the socialists tell you that you’ve been victimized by the upper class? Uselessly protesting for government handouts? Standing in a bread line?
Or will you be sitting cozy at home, having stashed your cash and savings in your mattress, waiting out the predicament? Will you be smart enough to put that money to good use, and buy productive assets which produce income for yourself and your family?
I know where I’d prefer to be standing. On my own two feet. Not in a bread line.
Does this sound serious? That’s because it is.
I started writing on this blog about a year ago, and have done so off and on since then. And in looking at the economy during this time closer than I ever have before, I’ve seriously become afraid for the future of my family.
As weird as it sounds, I have from time to time considered buying into the world of prepping, survivalism, and conspiracy theory, so that in the event that a coming deflationary crisis does occur, at least we’ll have the necessities of life.
I don’t expect you to do that, but I would encourage you to be watchful and cautious. Follow this blog, watch the news, guard yourselves from whatever might come. Protect your own financial future, because no one else will.
I could be over-blowing things here. But I can tell you one thing: eventually, this shabby house of financial cards that our country is living in will come crashing down, and I’m not going to be left standing outside in the cold when it does.
Thankfully, the crisis isn’t here yet, so we still have time to grow what we have. There are hundreds of fascinating and safe ways to "bank some coin" while the day is young!
I wrote just last week that things could start to get weird in the markets this fall, or at least sometime in the next few months. As I watch things happen, I’ll be providing plenty of opportunities for you to take advantage of in the coming weeks and months, so “Follow” what I have here on the blog and on Social Media.
You won’t regret it.
Live long and invest,
Jeremiah
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