Vern Gowdie – Markets and Money (Australia) –
Goldilocks has moved out of the woods and into the life of an international jetsetter.
They see her here, they see her there. Goldilocks is the everywhere girl (emphasis mine):
‘…the latest poll of global fund managers by Bank of America Merrill Lynch. Almost half of all the managers now expect above-trend growth and below-trend inflation, what is dubbed the Goldilocks economy (she wanted porridge that was not too hot, or too cold, but just right). That is the highest proportion recorded in the history of the survey.’
The Economist, 17 October 2017
‘Asian stocks inch up to new highs on “Goldilocks economy”’
Business Day, 13 October 2017
‘Canadian interest rates must be just right for a Goldilocks economy’
CBC 23 October 2017
‘China’s third quarter economic data are another reflection of a global Goldilocks economy in 2017…’
Bloomberg, 19 October 2017
And there are more lines on her visit to Eastern Europe.
And there is also this:
‘In the last year or two, the US economy has been called the “Goldilocks economy” because it has been rolling along “just right, not too hot and not too cold,” with both unemployment and inflation at the lowest levels in 30 years, a booming stock market, etc. Business Week has even proclaimed in a series of prize-winning special issues that the US economy has entered a “new era” in which rapid technological change (especially information technology) will make it possible for the US economy to continue to achieve both low unemployment and low inflation for the foreseeable future.’
But this account is not from her most recent travels.
This is the opening paragraph of a paper written by Fred Moseley (Professor of Economics at Mount Holyoke College, Massachusetts). The paper is titled: ‘The US Economy in 1999: Goldilocks meets the Big Bad Bear?’
Does any of this sound familiar…?
‘The main factor propelling consumer spending forward in recent years has been the booming US stock market. Stock prices have increased roughly 50% over the last two years, and have increased 150% since 1993. This very rapid increase of stock prices has greatly increased the wealth of US households, especially the small minority of households that own most of the corporate stock. This increasing wealth from the stock market has had a strong positive effect (called the “wealth effect”) on consumer spending — on the consumer spending of the rich, that is, who have enjoyed this wealth windfall.’
In the past two years the US share market has also risen around 50%.
And if we go back six years, the increase has been around 120%.
Do you recall the economic rationale Bernanke gave for the Fed’s unprecedented money printing experiment?
To create the ‘wealth effect’.
Provide an abundance of cheap money to push up asset prices. As people become wealthier, they spend more. Money will trickle down through the economy…enriching everyone. Sounds good…in theory.
But as we can see from Professor Moseley’s paper, the ‘wealth effect’ theory has been tested previously and found wanting.
Perhaps I’m wrong, but I thought the ability to learn from one’s mistakes was how civilisation progressed.
Obviously not with the Fed.
They keep serving up the same dish and expect it to taste differently…anyone else equate this to Einstein’s definition of insanity?
But the similarities between then and now don’t end there…
‘These households evidently feel that their increasing stock market wealth provides all the saving for the future that they need, and hence they do not have to save out of their current income (instead, they can spend all of their current income, and more!)’
Here’s a chart from the Federal Reserve Economic Data (FRED) on the US personal savings rate.
[Click to enlarge]
Note the current savings rate — around 3% — is on par with what it was in 1999.
It’s not yet as low as 2005/06 — the year before subprime lending started to implode — but it’s getting close.
The parallels don’t stop there. Professor Moseley made this observation in 1999:
‘…there is another danger that might lead to an even greater decline of investment spending: a “credit crunch” in which lenders refuse to lend to firms, or are willing to lend only at much higher interest rates…in recent months, a new type of credit crunch has appeared and threatens to be more severe: a credit crunch in the bond markets, in which investors are no longer willing to buy corporate bonds (except the highest grade), or are willing to do so only if these bonds offer a significantly higher interest rate (i.e. only if these bonds offer a higher “risk premium”).
In recent years — due to investors chasing yield — the issuance of junk bonds (high-risk corporate debt) has been on the rise.
The debt has been used primarily to refinance existing (higher cost) debt facilities, fund share buybacks, and to finance dividend payments. Very little has actually been invested in businesses to make them more productive.
This accounting trickery works well while confidence remains high and intelligence levels are low. But when those variables reverse — as they inevitably will — then we’ll see lines of ‘credit crunch’.
Those cracks in the corporate bond market may already be starting to appear.
From Barron’s on 4 November 2017: ‘Risk Is Rising on High-Yield Bonds’.
When starved of access to credit markets — to keep the illusion going — then it’s game over.
For a moment, let’s go back to 1999. The mood was very upbeat. The dotcom boom was euphoric.
But divorced from emotion, what was the data showing Professor Moseley?
‘I conclude that it is very likely that the US economy will fall into a recession within the next year or so.’
The US entered an official recession in March 2001.
Professor Moseley’s outlook was very accurate, but there was one thing he failed to predict…
‘Furthermore, would expansionary monetary policy be able to rally the stock market again, if the economy were slowing down and profits falling? Success would be less likely under these circumstances because of the already very high valuations of stocks at the present time. If profits are falling as a result of a declining economy, then either price-earnings ratios will rise even higher above today’s very high levels or stock prices will have to fall along with profits. At some point, it seems likely that the stock market bubble will burst and there will be very little the Fed can do about it.’
The good professor can be forgiven for thinking that there will be very little the Fed can do about a stock market crash.
The actions taken by the Fed after the dotcom bust and the GFC would’ve, in 1999, been deemed to be sheer recklessness…bordering on lunacy.
That’s how much the world has changed in the space of two decades.
What was once considered to be an act of financial irresponsibility (reserved for despotic nations like Zimbabwe) now passes for sound economic stewardship.
But the more things change, the more they stay the same.
Goldilocks is going to be mauled by another bear…and it’ll be far more ferocious than the one that awoke from hibernation in 2000.
To stay out of range of the bear’s claws, please go here.
Editor, The Gowdie Letter