Investors’ Addiction to Low Interest Rates Will Trigger Economic Collapse in 2019
The interest rate alone cannot explain why 2019 could trigger a global economic collapse.
The first hint of trouble came when Janet Yellen left the Federal Reserve in February 2018. The new chair, Jerome Powell, sped up the process of lifting rates from near zero 10 years ago to 2.25% now.
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But it’s a good place to start the narrative.
And while I’m still pondering why I’ve become so concerned about the higher chances of economic collapse, I will reveal a fact that few realize.
Nobody Really Knows How It Works
Economists and similarly inclined administrators and academics have no clue. They’re great at explaining things after the fact.
There’s a wealth of great books about the causes of the last recession or the Great Depression.
Sadly, however, economists, despite their mind-boggling equations that would bring tears of joy (or pain) to Albert Einstein’s eyes, don’t have what is known in the vernacular as a clue.
In other words, for all their knowledge and science (and it’s not their fault), economists don’t know what makes an economy grow.
And they don’t know what helps reduce debt. And debt is one of the biggest problems afflicting the U.S. economy.
Sure, tax cuts can work. But applying this solution, as Trump did in December 2017, often works better at encouraging families and individuals to spend more than inducing businesses in investing.
In fact, the tax breaks have contributed to lifting stock valuations to precarious heights.
Now, not even a year after the tax cuts were unveiled, the Dow Jones, the S&P, and the Nasdaq show a net loss in year-to-date terms. Clearly, the tax cuts haven’t resolved the problem of real growth.
And Then There’s the Federal Reserve
The Fed isn’t an elected body, accountable to Americans.
It’s a semi-private institution, seemingly accountable to no one. Yet, it makes decisions that affect Americans directly. Such decisions would be better left to elected officials, who would then be made accountable to voters.
The way it works now, nobody is accountable. When policies go wrong, economists retain their tenured posts at prestigious universities.
The bankers keep on banking even if the truckers are not trucking. And the politicians are left as clueless as everyone else. After all, they have little to say about the economy.
Perhaps one day, a genius enhanced by artificial intelligence or yet unknown technology, might be able to steer government policy in the right direction to achieve sustainable (i.e. long-term) growth.
As it happens, in the period roughly from 1945 to 1975, political leaders made economic choices based on an agreeable principle: encourage the spreading of wealth by aiming for full employment.
Economics was tied to politics. And in much of the West, politicians were accountable to their voters based on their ability to deliver “growth.”
It was that kind of optimism and outlook that stimulated massive infrastructure spending during the Eisenhower administration.
Even if you’ve never heard that name—or his famous nickname “Ike”—you may have driven over a major reminder of his legacy: the Interstate highway system, which cost the equivalent of $128.9 billion, of which the Federal Government paid $114.3 billion. (Source: “Federal Highway Administration,” U.S. Department of Transportation – Federal Highway Administration, last accessed November 22, 2018.)
Can you imagine what economists would say about a similar effort, were a president to encourage this kind of spending on a public project?
Will Trump Finally Start the Much Promised Infrastructure Spending?
President Trump, certainly, has made this point. But there’s little chance he will succeed.
That’s because he’s not the person in charge of the economy now.
The great evolution of finance that occurred after the end of the Cold War in 1990, and President Clinton’s deregulation of Wall Street in 1999, has virtually, if not officially, transferred control of the economy to the bankers.
Now, there have been many clichés about bankers, George Soros, and then some. But the problem with some clichés is that they do have a root, even a little one, in reality.
That reality will soon be hitting Americans where it counts: their bank accounts.
The merry-go-round on Wall Street has slowed down. Investors are starting to get nervous and they’re collecting their gains before things become really interesting in January 2019.
That’s when Democrats take over the House in January, distracting President Trump with more legal pressure, raising the specter of impeachment.
And who’s going to be the ultimate arbiter of the economy, growth, and the financial markets? Why, it will be the chair of the Federal Reserve, Jerome Powell.
He wasn’t elected. And, for all his efforts—the president has complained—Trump doesn’t have the power to stop Powell. Even the mere effort to persuade him to postpone the rate cuts will cause panic in the markets.
That formula, however, would not be so harmful if for the fact that it will make it abundantly clear that the stock market has improved, but not the real economy.
The Battle Is Between Wall Street and Main Street
Wall Street still rules over Main Street. Finance is supposed to serve the real economy; instead, the opposite is true.
The Federal Reserve, through its manipulation of interest rates, has taken the reins of the economy.
Since 2008, the Fed has allowed the U.S. monetary base to explode, unleashing an avalanche of dollars, maintaining the interest rate at zero.
However, rather than use the low rates to invest in jobs, factories, and infrastructure, as happened in the good old days before globalization, the low rates encouraged speculation in the stock market, whether in equities or other instruments like bonds and derivatives. The problem, now that the monetary supply will inevitably tighten, is one massive bubble.
And Powell literally has the needle that will burst the bubble in his hand.
But let’s assume the markets hold up just a little while longer to allow the bubble to gradually deflate rather than explode.
Would that save U.S. investors the trouble of having to seek alternative ways to invest their savings?
The answer is, of course, complex. Nevertheless, even if somehow stocks survived Powell’s painful interest rate medicine, the United States remains a part of the world economic system, which has become a domino.
Vulnerability to Global Shocks
Therefore, the U.S. remains vulnerable to global shocks. And all it takes is one medium-sized power to get the pieces to fall.
That, by the way, is why economic collapse can no longer be contained within a single country or zone.
Italy could well be the trigger.
The combination of money-tightening policies at the Fed and at the European Central Bank will likely unleash a new recession in the eurozone, starting from its most indebted economies.
Evidently, the higher the debt, the more funds go toward servicing it and the fewer funds available to stimulate growth.
Economic collapse will have its “conceptual” roots in Washington D.C., but it will manifest itself first as a European crisis.
What can you do to defend yourself? That has been the subject of recent articles and will continue to be the subject of forthcoming ones.
Clearly, however, many will turn to quality stocks—and by that, I mean safe stocks based on real prospects of growth, rather than the more dicey or speculative ones often going by the category of “growth stocks” (like the tech or FAANG stocks, for example).
The uncertainties of the present, which could transform to pure panic by the start of 2019, also warrant a re-evaluation of gold and precious metals.
But there’s an old saying that a man warned is half saved. Or better, forewarned is forearmed.
