Here, Joseph T. Salerno of the Ludwig von Mises Institute provides spot-on analysis of the Fed's pumping, pumping, pumping tactics in its continuing backstop of the U.S. Treasury's machinations to continue expanding federal spending.
President Obama tells us the federal government simply must keep spending money, else we will surely suffer a dismal fate. Never mind that the money the U.S. Treasury is spending is simply new money created by the Fed.
Somehow, I think that even people who have never studied economics or finance really do understand the vacuousness of the President's argument. I think that most people really do understand my well-rehearsed pronouncement in EconoBlast, "you can't borrow what hasn't already been produced and saved."
Check out the nearby chart, which is one of the most interesting in Salerno's analysis.
The chart "Total Household Net Worth as a Percent of GDP" reveals fascinating evidence for a dark hypothesis that I can't seem to shake, despite its tin-foil-underwear implications. Allow me to explain.
GDP is the total dollar value of final goods and services produced within our geographical borders in a year. Total Household Net Worth (let us call it THNW) is the dollar value of assets minus liabilities owned by American households. Up until 2008, a whole bunch of that net worth resided in the form of residential housing. A whole bunch still resides there, but not as much as in 2008.
Net worth is accumulated savings of households from income earned over time --- in a word, "capital." Saving is that part of household income that is not consumed each year to sustain life and finance household consumption spending. With those basic financial definitions in place, let's explore the information revealed by the chart of THNW as a percent of GDP over time.
Just as Salerno says, THNW as a percent of GDP fluctuated in the band of 300% to 350% from 1952 through just about the end of the 1980s. Notice, though, the downward trend in the ratio from the early 1960s through the decade of the 1970s.
Remember the decades of the 1960s and 1970s? I do. America was fighting the Vietnam war in the 1960s (I was in that war; draft, you know). With that war dispatched, America began waging President Lyndon Johnson's "War on Poverty" near the end of the decade. Throughout the decade of the 1970s, price inflation in the United States grew to reach 10% per year by mid-decade and approached 14% by the end of the decade.
Those of us who lived through the decades of the 1960s and 1970s pretty much understood that we were not really becoming wealthier as the prices of oil and gasoline continued their upward march with the Fed pumping furiously on the money supply. America had to finance its misbegotten war in Southeast Asia and its War on Poverty somehow. It did so through the graces of the Fed creating ever more money for the U.S. Treasury to spend.
Paul Volcker, Chairman of the Federal Reserve, appointed by Jimmy Carter in 1979 and reinstated by Ronald Regan four years later, righted the ship at the opening of the decade of the 1980s. Price inflation had to be stopped, and Volcker did just that. He did it by bursting the bubble in U.S. Treasurys that his predecessor Chairs of the Fed, Arthur Burns and G. William Miller, had pumped up to finance the Vietnam War and the War on Poverty.
Following Volcker's bursting of what I will call the "Wars Bubble," the ratio of THNW to GDP stayed above 300% but below 350% until the mid-1980s. The ratio began to grow in the mid-1980s as the economy enjoyed real growth, not inflation growth, reaching a new plateau just above 350% throughout the decade of the 1990s.
The decade of the 1990s, the most economically prosperous time ever on planet earth, saw the ratio of THNW to GDP rise to just above 350%, until mid-decade. Beginning in 1996, the ratio began to rise on trend, topping 450% in the year 2000. Of course the ratio began to rise. The Fed, under guidance from Chairman Alan Greenspan, was pumping away, fueling what is now called the "Dot-Com" bubble in the stock market.
Like all financial bubbles pumped up by money creation --- a phenomenon that Salerno points out is a repeating event --- the Dot-Com bubble had to explode, and it did. I remember the Dot-Com bubble well. Everyone was getting rich quick in the stock market. American households were elated with their new-found wealth. But of course, the new-found wealth wasn't real; it was just a financial asset bubble.
The ratio of THNW to GDP plummeted, as it must, when the Dot-Com bubble burst. But this time the Fed was determined to fight. Greenspan continued to pump. And a new bubble was born. We know it today as the "Housing Bubble." Pump, pump, pump went the Fed, and up, up, up blew the housing bubble. Americans were once again riding high and getting wealthy. Anyone could do it. Even people who had insufficient income to borrow money to buy a car could borrow money to buy a house.
With the help of the Fed, the Housing Bubble raised the ratio of THNW to GDP to new, dizzying heights, pushing above 450% with a steely eye on 500%. But, as always, like all other financial bubbles pumped up by the banking system, the Housing Bubble literally exploded in 2008.
But the new Fed Chair, Helicopter Ben Bernanke, would not take this bubble bursting sitting down. Chairman Bernanke has led the Fed's pumping, pumping, pumping with previously unseen zeal since the bottom of the Great Recession, continuing to this day. Guess what. A new bubble has formed. Asset prices in particular sectors of the economy are rising, rising, rising. I wrote about this new bubble a few days ago here.
Do you think this new bubble will burst? Of course you do. It has to. Now here comes the dark part that I can't seem to shake. All that fake net worth above the 350% of GDP mark has to get wiped out somehow. Real wealth is about real stuff. Real wealth is not about money. We all know that real GDP around the world is languishing, even as the ratio of THNW to GDP in America is back on the rise, thanks to the pumping, pumping, pumping of the Fed.
So what's dark about that observation? I don't think bubbles just burst naturally, anymore than I think that bubbles get pumped up naturally. What's usually called "the business cycle" isn't a naturally occurring phenomenon like hurricanes are. It takes a flawed banking system led by a central bank (or banks too big to fail acting in concert) to pump up an asset bubble. Always has, always will.
World history, not just American history, is full of asset bubbles created by pumping, pumping, pumping fiat money. The pumping requires the confluence of strong central governments and highly concentrated banking. The banking can be highly concentrated under the leadership of a central bank (as it is now), or it can be highly concentrated under the collusion of a few big banks (as it was in the run up to creation of the Fed in America in 1913).
Everyone can't be wealthy at the same time in a world of scarcity. But central banks can pump, pump, pump up asset bubbles for a time, creating the illusion of wealth. But because it is illusory wealth, not real wealth, the fake wealth must be extinguished somehow. Why? Because paper wealth cannot long buy real goods and services in a world of scarcity. As Robert Heinlein put it in The Moon Is A Harsh Mistress, "there ain't no such thing as a free lunch." I call that line the "economic maxim."
Did you know back in 2008 when the bubble would burst? Neither did I. I knew it would burst, but I didn't know when. But some people knew when. That's the dark part. Financial bubbles don't just burst. After all, the pumping, pumping, pumping by the Fed could be continued to stave off the explosion. Of course, continued pumping would eventually lead to a rising and high rate of general price inflation across all goods and services, instead of just rising asset prices. The Fed cannot allow that; way too obvious what's going on if price inflation gets out of hand. That's what happened in the decade of the 1970s, until Volcker burst the bubble on purpose in full view of one and all.
We humans learn. The Fed has learned. The Fed still pumps up asset bubbles, but it doesn't keep pumping so long that general price inflation gets way out of hand. The new bubble in town will be burst. I don't know when. Wish I did; I could become very wealthy if did know.
If you have your 401(k) or your 403(b) back in the stock market just now, be forewarned. If you have your wealth in U.S. Treasurys, thinking those will surely be safe assets, be forewarned. If you have your wealth in corporate junk bonds just now, because the yield over U.S. Treasurys is the only yield in town, be forewarned. Even if you have your wealth in Midwestern farmland acreage, just now, be forewarned.
Nearby is one more chart I stole from Salerno's excellent article.
The Wilshire 5000 index can be taken to be a record of what the stock market did over time. Let's see; pumping, pumping, pumping --- kablooey! Pumping, pumping, pumping --- kablooey! The next kablooey may not be far away. I don't know when, but someone will know before it happens.
This new bubble in town will also be burst. Those few who somehow learn about the impending kablooey will not lose their wealth. Only the dumb money will be lost. The smart money will be out of the bubble assets just in time. I wonder how the smart money will know when to leave
I hope that Peter Schiff (check it out here) is off the mark this time, but I don't really think he is.
President Obama tells us the federal government simply must keep spending money, else we will surely suffer a dismal fate. Never mind that the money the U.S. Treasury is spending is simply new money created by the Fed.
Somehow, I think that even people who have never studied economics or finance really do understand the vacuousness of the President's argument. I think that most people really do understand my well-rehearsed pronouncement in EconoBlast, "you can't borrow what hasn't already been produced and saved."
Check out the nearby chart, which is one of the most interesting in Salerno's analysis.
The chart "Total Household Net Worth as a Percent of GDP" reveals fascinating evidence for a dark hypothesis that I can't seem to shake, despite its tin-foil-underwear implications. Allow me to explain.
GDP is the total dollar value of final goods and services produced within our geographical borders in a year. Total Household Net Worth (let us call it THNW) is the dollar value of assets minus liabilities owned by American households. Up until 2008, a whole bunch of that net worth resided in the form of residential housing. A whole bunch still resides there, but not as much as in 2008.
Net worth is accumulated savings of households from income earned over time --- in a word, "capital." Saving is that part of household income that is not consumed each year to sustain life and finance household consumption spending. With those basic financial definitions in place, let's explore the information revealed by the chart of THNW as a percent of GDP over time.
Just as Salerno says, THNW as a percent of GDP fluctuated in the band of 300% to 350% from 1952 through just about the end of the 1980s. Notice, though, the downward trend in the ratio from the early 1960s through the decade of the 1970s.
Remember the decades of the 1960s and 1970s? I do. America was fighting the Vietnam war in the 1960s (I was in that war; draft, you know). With that war dispatched, America began waging President Lyndon Johnson's "War on Poverty" near the end of the decade. Throughout the decade of the 1970s, price inflation in the United States grew to reach 10% per year by mid-decade and approached 14% by the end of the decade.
Those of us who lived through the decades of the 1960s and 1970s pretty much understood that we were not really becoming wealthier as the prices of oil and gasoline continued their upward march with the Fed pumping furiously on the money supply. America had to finance its misbegotten war in Southeast Asia and its War on Poverty somehow. It did so through the graces of the Fed creating ever more money for the U.S. Treasury to spend.
Paul Volcker, Chairman of the Federal Reserve, appointed by Jimmy Carter in 1979 and reinstated by Ronald Regan four years later, righted the ship at the opening of the decade of the 1980s. Price inflation had to be stopped, and Volcker did just that. He did it by bursting the bubble in U.S. Treasurys that his predecessor Chairs of the Fed, Arthur Burns and G. William Miller, had pumped up to finance the Vietnam War and the War on Poverty.
Following Volcker's bursting of what I will call the "Wars Bubble," the ratio of THNW to GDP stayed above 300% but below 350% until the mid-1980s. The ratio began to grow in the mid-1980s as the economy enjoyed real growth, not inflation growth, reaching a new plateau just above 350% throughout the decade of the 1990s.
The decade of the 1990s, the most economically prosperous time ever on planet earth, saw the ratio of THNW to GDP rise to just above 350%, until mid-decade. Beginning in 1996, the ratio began to rise on trend, topping 450% in the year 2000. Of course the ratio began to rise. The Fed, under guidance from Chairman Alan Greenspan, was pumping away, fueling what is now called the "Dot-Com" bubble in the stock market.
Like all financial bubbles pumped up by money creation --- a phenomenon that Salerno points out is a repeating event --- the Dot-Com bubble had to explode, and it did. I remember the Dot-Com bubble well. Everyone was getting rich quick in the stock market. American households were elated with their new-found wealth. But of course, the new-found wealth wasn't real; it was just a financial asset bubble.
The ratio of THNW to GDP plummeted, as it must, when the Dot-Com bubble burst. But this time the Fed was determined to fight. Greenspan continued to pump. And a new bubble was born. We know it today as the "Housing Bubble." Pump, pump, pump went the Fed, and up, up, up blew the housing bubble. Americans were once again riding high and getting wealthy. Anyone could do it. Even people who had insufficient income to borrow money to buy a car could borrow money to buy a house.
With the help of the Fed, the Housing Bubble raised the ratio of THNW to GDP to new, dizzying heights, pushing above 450% with a steely eye on 500%. But, as always, like all other financial bubbles pumped up by the banking system, the Housing Bubble literally exploded in 2008.
But the new Fed Chair, Helicopter Ben Bernanke, would not take this bubble bursting sitting down. Chairman Bernanke has led the Fed's pumping, pumping, pumping with previously unseen zeal since the bottom of the Great Recession, continuing to this day. Guess what. A new bubble has formed. Asset prices in particular sectors of the economy are rising, rising, rising. I wrote about this new bubble a few days ago here.
Do you think this new bubble will burst? Of course you do. It has to. Now here comes the dark part that I can't seem to shake. All that fake net worth above the 350% of GDP mark has to get wiped out somehow. Real wealth is about real stuff. Real wealth is not about money. We all know that real GDP around the world is languishing, even as the ratio of THNW to GDP in America is back on the rise, thanks to the pumping, pumping, pumping of the Fed.
So what's dark about that observation? I don't think bubbles just burst naturally, anymore than I think that bubbles get pumped up naturally. What's usually called "the business cycle" isn't a naturally occurring phenomenon like hurricanes are. It takes a flawed banking system led by a central bank (or banks too big to fail acting in concert) to pump up an asset bubble. Always has, always will.
World history, not just American history, is full of asset bubbles created by pumping, pumping, pumping fiat money. The pumping requires the confluence of strong central governments and highly concentrated banking. The banking can be highly concentrated under the leadership of a central bank (as it is now), or it can be highly concentrated under the collusion of a few big banks (as it was in the run up to creation of the Fed in America in 1913).
Everyone can't be wealthy at the same time in a world of scarcity. But central banks can pump, pump, pump up asset bubbles for a time, creating the illusion of wealth. But because it is illusory wealth, not real wealth, the fake wealth must be extinguished somehow. Why? Because paper wealth cannot long buy real goods and services in a world of scarcity. As Robert Heinlein put it in The Moon Is A Harsh Mistress, "there ain't no such thing as a free lunch." I call that line the "economic maxim."
Did you know back in 2008 when the bubble would burst? Neither did I. I knew it would burst, but I didn't know when. But some people knew when. That's the dark part. Financial bubbles don't just burst. After all, the pumping, pumping, pumping by the Fed could be continued to stave off the explosion. Of course, continued pumping would eventually lead to a rising and high rate of general price inflation across all goods and services, instead of just rising asset prices. The Fed cannot allow that; way too obvious what's going on if price inflation gets out of hand. That's what happened in the decade of the 1970s, until Volcker burst the bubble on purpose in full view of one and all.
We humans learn. The Fed has learned. The Fed still pumps up asset bubbles, but it doesn't keep pumping so long that general price inflation gets way out of hand. The new bubble in town will be burst. I don't know when. Wish I did; I could become very wealthy if did know.
If you have your 401(k) or your 403(b) back in the stock market just now, be forewarned. If you have your wealth in U.S. Treasurys, thinking those will surely be safe assets, be forewarned. If you have your wealth in corporate junk bonds just now, because the yield over U.S. Treasurys is the only yield in town, be forewarned. Even if you have your wealth in Midwestern farmland acreage, just now, be forewarned.
Nearby is one more chart I stole from Salerno's excellent article.
The Wilshire 5000 index can be taken to be a record of what the stock market did over time. Let's see; pumping, pumping, pumping --- kablooey! Pumping, pumping, pumping --- kablooey! The next kablooey may not be far away. I don't know when, but someone will know before it happens.
This new bubble in town will also be burst. Those few who somehow learn about the impending kablooey will not lose their wealth. Only the dumb money will be lost. The smart money will be out of the bubble assets just in time. I wonder how the smart money will know when to leave
I hope that Peter Schiff (check it out here) is off the mark this time, but I don't really think he is.
2 comments:
Thanks for the post.
I've not seen the THNW vs. GDP chart before.
While it seems intuitive that pumping permitted the dot-com and housing bubbles, it would be interesting to see this clarified through a breakdown of the THNW by asset class over this period. The data should show a high percentage of stock portfolio composing the THNW during the 90s and the same for home equity in the 00s.
Aside from easy money, it seems to me there must be an element of "fad" to bubbles. Dot-com stocks, for example, were not only new, but they were like "Tickle Me Elmo." Everyone was talking about the home runs they were hitting with tech stocks. IPOs were wild. And the more people talked, the more they felt they had to jump on the train before it left the station. I confess to having done a little of this myself.
Clearly, the same thing happened with housing. Neighbors saw neighbors getting "rich" with artifically escalating home prices. Bankers saw their competitors getting rich by creating clever new financial-vehicles to ride the wave, and regulators (as usual) had no idea what was going on because institutionally they will always be years behind active participants in the industry.
The question remains... Where does one put money these days? Holding cash and waiting for the shoe to drop may be one option, but inflation may eat into that strategy. Precious metals might be a better parking spot, for now.
It is pitiful that the primary consideration in investment is not what product or service is valuable to society, or what company or innovation is attractive because of the value it adds to the world. No, now we spend all our time trying to figure out what the money manipulators will do to our investments, and how to shield it from them. The worst folks don't sit around and wait, they actively try to influence monetary and fiscal policy to their benefit.
The fundamental problem is the lack of meaningful limits on monetary policy.
Maybe we should all just pitch tents in a city park and pee on the statues.
Fabulous comment, Mike.
There most certainly is a psychological component to a financial bubble. Lots of literature in behavioral finance on that. By their very nature, bubbles are fad phenomenon, as they have always been, dating way back. Check out the history of the Tulip Bubble of the 1630s.
You are certainly right about the sorry condition of investing these days, too. Trying to stay ahead of the Fed and the its shenanigans is a serious challenge. In my darker moments thinking about financial markets, I must confess that conspiracy theories rise to the top. It is hard to believe that some people behind the scenes, well placed, don't acquire enough information to avoid the kablooeys that always end the financial bubbles. The smart money will be out of the market just ahead of the explosion. I guess you have to play golf with the right people?
In my own case, I'm invested in just three categories right now. First, my house. Second, 90-day Treasuries. Third, a rather smallish amount of gold ETF.
I am waiting for the next kablooey, at which time I will go back into the stock market in the form of a very broad-based, low cost ETF, such as the Vanguard Total Stock Fund. I will ride the next secular bull market back up. I am waiting patiently for the next kablooey.
I plan to go back into the market after it drops at least 40%. I won't try to wait until what one might guess is the absolute bottom. I don't know any way to do that. So, I will likely have to endure an initial decline of another 10% before the next secular bull trend begins.
How will I know when to sell back out of the market? I won't. I will exit well before the top, just as I have during this most recent bubble. I have doubtless missed additional return I could have enjoyed, had I stayed in the market during the past year, for example. Problem is, the kablooey could have happened during the past year and wiped me out. I am content not to be a pig. Pigs get slaughtered, as the Wall Street expression goes.
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