Tuesday, 16 August 2022 — Paris, France

By Vern Gowdie Editor, The Daily Reckoning Australia

[8 min read]

• What if questions open your mind to possibilities
• Some ‘what if’ questions to ponder

Dear Reader,

What if, in September 1929, you are a highly regarded Yale University economist who believes ‘shares have reached a permanently high plateau’?

From the 3 September 1929 edition of The New York Times:

What if your conviction is so absolute, you invest everything you own in the market?

History provides the answer to the ‘what if’ questions (emphasis added):

‘Irving Fisher, one of the leading economists in the U.S. at the time, was heavily invested in stocks and was bullish before and after the October sell offs; he lost his entire wealth (including his house) before stocks started to recover.’

Economic History Association

What if Irving Fisher had held a different belief?

What if he’d determined investment markets operate in cycles…rotating from high to low and back again?

Life would’ve been vastly different for him.

What if questions open your mind to possibilities

In July 2005, Ben Bernanke (former US Federal Reserve Chairman) was asked in a CNBC interview (emphasis added):

‘What is the worst-case scenario if in fact we were to see [housing] prices come down substantially across the country?’

Bernanke’s reply was (emphasis added):

‘Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.’

Bernanke deemed the possibility of the ‘what if’ scenario to be…unlikely.

With hindsight, we know Bernanke was wrong, wrong, and wrong.

Irving Fisher and Ben Bernanke made the mistake of taking ‘what has been’ as a permanent condition…what has been good will continue to be good…or, even better.

Hyman Minsky’s hypothesis — ‘stability creates instability’ — could have saved them both a great deal of embarrassment.

The psychological process goes something like this…

The longer the period of price stability, the greater the likelihood we think this pattern will continue.

Safe in the belief share/property/crypto values never go down, investors discount risk out of the investment equation.

With a guaranteed road to riches — because prices only ever go up or at worse, stabilise — the thinking becomes ‘why wouldn’t you borrow as much as you can to participate in the rapidly appreciating asset class’?

A prolonged period of price increases lulls people into a false sense of security.

Flashing dollar signs blind them to the risks in their financial overreach.

Based on the physics of ‘for every action there is an equal and opposite reaction’, history shows us ‘the longer the period of stability, the greater the eventual instability’.

When you preface a question with ‘what if’, you open your mind to possibilities and alternatives.

Some ‘what if’ questions to ponder

Over the past few years there’ve been several ‘what if’ questions I’ve been grappling with.

What if the past 60 years of economic growth and financial prosperity wasn’t normal?

Since the mid-1960s, US debt (public and private) has increased from US$1 trillion to US$90 trillion:

This chart is a classic representation of the boiling frog theory put into practice.

Year after year, a little more debt was added. People became used to the higher debt loads.

Reduce rates a little and they could dial up debt levels a little more.

It’s this slow and almost unnoticed layering of debt levels that creates the mindset of ‘normality’. Year after year, decade after decade, debt levels accumulate.

The concept of constant growth (albeit interrupted by the occasional recession) is not only taken for granted but is expected.

Growth, growth, and more growth is the mantra.

But what if the ‘growth’ of the past 60 years has largely been a function of expanding debt levels in the global economy?

We’ve made tremendous advances over the past six decades — technology and healthcare immediately come to mind.

However, to avail ourselves of these advancements and improve our lifestyles, it’s required us, as a society, to go deeper and deeper into debt.

Accessing these ‘mod cons’ and ‘medical marvels’ with more savings and less debt would’ve delivered a much slower pace of growth.

Accelerated growth, fuelled by high octane debt, created our ‘normal’ view of economic development.

This artificially created growth is evident in the performance of the Australian share market pre- and post-1980.

From 1875–1980 (105 years), our market averaged a compound growth rate of 4.5% per annum.

Since 1980, the All Ords annual compound rate accelerated to 6.6% per annum.

Is it just a coincidence that the share market’s increased growth rate has occurred precisely at the same time the world went deeper into debt?

Or did decades of debt-fuelled economic growth propel the share (and property) market/s to growth rates well above their historic averages?

Personally, I think it’s the latter.

What if debt levels keep rising to maintain past growth levels?

It’s possible. But to quote Bernanke…unlikely.

Trees DO NOT grow to the sky and, as history shows, neither does debt.

The higher the debt pile increases, the greater the instability in the structure.

Compounding debt levels is not an infinite exercise.

If it was, the term ‘debt crises’ wouldn’t exist.

If you recognise that debt accumulation (which these days is being used in greater quantities for unproductive purposes) has a use-by-date, then the next what if question is:

What if in the coming years and decades, debt levels fall (not even collapse)?

Inflation (the air in the credit bubble) could be replaced by deflation (the air escaping the credit bubble). I know in the current environment this sounds absurd. But so too did the prospect of the Great Depression in 1928 and the thought of a nationwide US property collapse in 2005.

The advent of deflation heralds in growth rates much lower than ‘normal’…what we’ve been conditioned to expect from the past six decades.

Growth assumptions (based on what has been, will continue to be) on population, household formation, property values, wages, welfare, share prices etc., will all be thrown into disarray.

In this what if scenario, using past data as a reliable guide to future outcomes would be sheer folly.

Government budgets — based on rosy growth projections — would go deep into the red.

On an individual level, retirement income projections based on 6%-plus per annum compound return, would fall well short of the mark.

Property investors relying on an assumed level of capital growth (to offset income losses incurred from negatively geared property) is likely to scuttle many a well laid plan.

Plans made with all good intentions, but based on incorrect assumptions, are bad plans.

Garbage In, Garbage Out…GIGO.

Making growth assumptions based on an extended period of unprecedented debt growth is, in my opinion, a mistake...permanently high plateaus DO NOT exist.

The road travelled is unlikely to be the one we’re going to travel in the coming years and decades.

The ‘stability’ of the past 60 years has culminated in a mindset of excessive risk-taking.

It’s this collective thinking that’s made our economic and financial system highly unstable and extremely fragile.

What if I’m wrong?

Then adopting a cautious approach to your assumptions means you’ll be in for a pleasant surprise…a case of ‘underpromise and overdeliver’.

What if I’m right?

You’ll be so glad you adopted a more conservative approach to the allocation of your capital, reduction of debt, and living within your means.

Institutional economists (drawing on past performance data) all suggest mostly positive economic conditions ahead. Are they right? Or are they falling into the same trap as Fisher and Bernanke?

History clearly shows that good and bad times DO NOT last forever.

Excesses need to be corrected.

The Great Depression was 92 years ago — the further we go away from the last one, the closer we are to the next one.

What was the cause of the Great Depression?

A debt build-up that began in 1880 and ended in the 1930s…it took around six decades for stability to create instability.

The latest US debt-to-GDP reading is 370%...well above the levels reached in the early 1930s:

What happened after the Great Depression was unlike anything anybody had experienced in their lifetimes.

At the height of the Roaring Twenties, hardly anyone would have considered ‘What if this is too good to be true? What if this all ends?’.

Failure to consider the ‘what if’ scenarios left society ill-prepared for an abrupt reversal of fortunes.

The question thinking investors of today need to seriously consider is…

What if this happens again?

Are you financially and emotionally prepared for tougher economic times?

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

Last week, Massachusetts signed onto the Great Transition crusade. From The Washington Post:

‘Described as a “landmark bill,” the Massachusetts climate legislation notably includes a provision — the first of its kind for the state — that would allow 10 municipalities to legally ban fossil fuel infrastructure in new and major construction projects. With this policy, certain cities and towns in Massachusetts could soon join others across the country that have taken similar steps to change local building codes to block the use of fossil fuels, such as natural gas — meaning many people who want gas stoves or furnaces are probably out of luck in these places.’

What if they’re wrong? What if trying to change the Earth’s climate is a wild goose chase?

The Pentagon was in the news last week too. In what CovertAction calls the ‘Most Bloated Military Budget in History’, Democrats and Republicans joined hands to deliver defence contractors a US$850 billion payday — a US$45 billion increase.

Supporters say the US needs to spend such huge amounts of money to counter the many threats they’ve managed to stir up — Russia, China, terrorists, gender inequality!

A lifetime setback

But what if they’re wrong? What if all that spending actually weakens the US economy…frightens foreigners…and causes potential enemies to ‘gun up’ themselves?  

Terrorists…Chinese…Russians — aren’t we pushing them to find new forms of money…new weapons…new friends?

What does it matter if you’re wrong? 

Marry the ‘wrong’ person, for example, and you might dread every breakfast.

Making the wrong career choice, too, could be a lifetime setback.

In matters of public policy, the consequences of wrongness are directly proportional to the ambition of the undertaking. Generally, the grander the project, the greater the damage. Many public policies are just reflections of a consensus — drive on the right (in the US)…don’t throw trash out the window — and do little damage.  

Otherwise, they’re threats to life and property. They impose the fads of the ruling class upon everyone else and divert time and resources from what ‘the people’ actually want.  

Does that make sense? We hope so; if not, we’d have to revise our entire weltanschauung.  

And now…you’re faced with a choice. You can believe the ‘inflation has peaked’ narrative, for example. If it’s true, the Fed can now ease off its ‘tightening’, and soon return to doing what it does best — inflating.  

If so, you might want to load up on stocks now…counting on a repeat of the money printing, interest rate falsifying, bubble extravaganza of the last 13 years.    

But what if you’re wrong?

Of course, you could be wrong in either direction. If you stay out of stocks, you could miss another big upswell. But if you jump in, you could get whacked…losing half your money. Maybe more.

That which we do not know

We have no idea whether stocks are going up or down in the short term. Nor do we know what will happen to prices of consumer items. But we don’t sweat the small stuff…nor fret about things we cannot know. Will we be happier if we lower carbon emissions? Should the people of the Donbas be free from Ukrainian control? Will Bitcoin [BTC] go back to US$30,000? Darned if we know!

What we aim to do here is to look at what OUGHT to happen. We connect the dots to see a bigger pattern — the Primary Trend. If we get that right, we won’t worry about the ups and downs along the way.

Since the late ‘90s, the primary trend has been driven by two things. First, Fed liquidity boosted asset prices and queered the entire economy. Second, globalisation (or more particularly, the entry of hundreds of millions of Chinese into the world’s manufacturing economy) helped to keep consumer prices down.

Now, it looks as though both of those things are played out. There aren’t many more peasants moving to the cities to find work, and the feds seriously disrupted output with their COVID lockdowns, stimmy cheques, and other measures. Those drinks have been poured; they’re not going back into the bottle anytime soon.  

This puts the Fed in a tight spot. It’s ‘inflate or die’. 

It can’t ‘inflate’ because it would risk runaway inflation. (Gasoline, for example. Even after the price decline of the last month, it is still 50% higher than it was last year. Producer prices ‘in the pipeline’ are still going up at nearly 10% per year.)  

Since it can’t inflate, the bubble must die. And the Fed is puncturing it, with tiny daggers…50–75 basis points each. The Fed Funds rate is still about 600 basis points (6%) below the CPI (now 8.5%). It needs to get ahead of inflation…not tarry 600 basis points behind. Otherwise, it has no rates to cut in the face of a recession.  

And if it stops raising rates, or even reverses course as the recession deepens, consumer prices will go up…and the whole system risks going into an Argentine-like chaos.  

Either way – killed by inflation or by rate hikes – the Primary Trend of the last 35 years is a goner.   

It will be a long, slow, on-again, off-again, confusing show. Stocks will slump. Then they will bounce up again. Consumer prices will go up…down…and up again. ‘Experts’ will be right…and wrong.

Only years from now will we see the new primary trend clearly. 

Regards,

Bill Bonner,
For The Daily Reckoning Australia