YOUGHAL, IRELAND – “It’s all part of a plan,” explained a colleague. “Trump is not book smart; he’s smart like a fox.”
“He knows that Americans need to see some economic improvement in time for the next election. And there really isn’t any.
“But if he can get the Fed to cut rates a couple times… and if he settles all these trade wars… he figures the economy will appear to be in great shape for the 2020 election.”
Start a quarrel. Stop the quarrel. Claim victory. Cut rates. Get re-elected.
Simple enough. And maybe it will work.
It seems to work well enough on the stock market. The S&P 500 set a new record high yesterday. The Dow is still bumping up against its all-time high. Investors seem to be anticipating an end to the trade quarrel and the beginning of a new cycle of lower interest rates.
Is that the plan? We don’t know. Will it work? We don’t know that either.
So, let’s turn to what we think we do know. We’re already halfway through the year; this is a good time to review.
We’re now at what must be near the end of the longest business cycle expansion in U.S. history. We’re also at a record high in the stock market… after a 10-year march to the top, with prices more than 200% higher than they were in 2009.
We know, too, that both of these things were made possible by a record expansion of the U.S. base money supply – inflation, in other words.
Through its quantitative easing (QE) program, the Federal Reserve has added more money to the U.S. monetary system in the last 10 years than it added in the previous 90 years of its existence.
Not only that, by lowering its key interest rate below the level of consumer price increases, it made borrowing more attractive than saving. Borrowed money, too – about $20 trillion has been added to the nation’s total debt in the last 10 years – adds to the available “money supply.” Again, more inflation.
Inflation – by definition, experience, and theory – increases the amount of money in circulation. But it does not increase the amount of stuff you can buy with it.
The law of supply and demand tells us that, ceteris paribus, prices rise. This is another way of saying that the feds have “debased” the currency; money becomes less valuable. Each unit buys less stuff.
If the new money goes into the system through the consumer channel – tax cuts, spending increases, giveaway programs, wars, etc. – you can expect consumer prices to rise. If it goes into the system via monetary policy – lower interest rates or QE – the result is more likely to be an increase in capital prices (prices for stocks and bonds).
It is not a coincidence that the rich got so much richer in the last 10 years than at any other period in history. In effect, the Fed gave them money.
Of course, it wasn’t that simple or that obvious. The feds may have really thought they were “stimulating the economy” rather than simply robbing the middle classes to pay off the rich. And it did have a stimulating effect on sales of luxury cruises, Long Island estates, and bottles of Dom Perignon.
But most of the country was not helped. As the 1% got richer, the 90% got poorer. Those in between stayed where they were.
The only real asset most people have is their time. But by 2018, it took about twice as many hours of work for the average man to buy the average house or the average pickup truck as it had in the 1970s.
The Fed’s inflation inflated the asset prices of the rich; it added not a second to the working man’s time… Nor did it increase the wealth of the economy.
Inflation is just a trick… a deceit. Imagine if the feds sent everyone a check for $1 million. We’d all be rich, right? Of course not. Prices would rise. And we’d all soon be back where we started.
But between the time we opened our checks… and prices rose to meet them… we would feel rich. We’d spend as though we were rich. And merchants and manufacturers would step up output to meet the new demand. So, it would seem like a real boom… for a while.
This is the so-called “wealth effect” that the feds were banking on. If higher stock prices make people feel richer, they’ll go out and spend!
But a business can’t really make a profit by selling goods and services to people who can’t really afford them. And it wouldn’t be long before consumers, businesses, and investors realized that they had overspent, overbuilt, and over-extended themselves.
Then, they’d have to cut back… producing a bust that would be equal and opposite to the fake boom that preceded it.
Buy Products With Products
Every boom that is based on inflation, rather than on real earnings, is doomed to fail. Because, as French economist Jean-Baptiste Say put it, you buy products with products, not with money.
He meant that real wealth is the ability to provide goods and services to others – ultimately, a measure of time and your productivity. Time cannot be increased. Only productivity can be improved. But it is a long, demanding process.
And it doesn’t help to hand out pieces of paper with green ink on them. Instead of stimulating growth and productivity, inflation does just the opposite. It distorts, disguises, and censors the key price information that people need to make decisions.
The result is always negative – bubbles, crises… and lower growth rates. Smooth out the growth rates – by looking at the trailing 10-year average – of the last 20 years, and you see that they are barely half of those of the previous 20 years.
And that brings us back to Richard Russell’s old dictum: Inflate or die. Real GDP growth is declining. A recession is coming. And the only way the feds can keep this inflationary expansion going is to inflate more.
Where does this lead?
Tune in tomorrow…