Saturday, August 22, 2015
Dow Jones industrial average falls 530 points
Monetary and fiscal policy have been largely ineffective the last six years. Our economy has entered a new phase that I believe is little understood by economists. Excessive regulation and policy uncertainty are hurting us and for that the only solution is less and better government.
In the meantime there have been excesses even in this anemic recovery and the time has come for a new downturn in the business cycle and correction. I think that is what we are seeing with this latest stock market drop. So tighten your seat belts and hold on tight, we are going down.
The market continues to say that economic growth will remain anemic for the most part for the next couple of quarters. We are finally beginning to see why the severe drop in oil prices last year was really a harbinger of slower growth to come. Now past the mid-point of the 3rd quarter, oil prices have re-started their move downward and guidance with a number of companies is indicating lower values ahead.
The market is declining because economic activity, five years into the "recovery" is going to be anemic for the next quarter or two or three. The jury is finally in. The collapse of oil prices last year was a harbinger of slower consumption due to lessened business activity, not a "gift" so consumers would have more money in their pockets. Obviously, that last idea is proving to be inconsequential as we watch consumer companies lower their guidance.
Let's understand that part of the problem comes from the belief of progressives that they can use science and "rational" interventions in the economy to do things better. Instead they've given us a sluggish economy. Here is why.
Economics, the "science" they like to use, is like a horse on two legs, only the two legs that can be quantified: how much money the government spends, and the other how much it prints and the price it gives it. The other two, which can't be quantified and are therefore always ignored, are the stranglehold of regulation on the flexibility of the economy, and investor trust in the policies of the government.
The first, regulation, is like the brake pedal on a car. You can step all you want on the gas (spending and printing) but if your foot is also on the brakes you won't go much faster.
The second, policy uncertainty, is like going up a steep mountain without knowing what is on the other side. Investors like some degree of predictability for their investments but currently the future they see is one in which the costs in two major sectors affecting the whole economy, healthcare and energy, face the certainty of huge unsustainable increases because of the preferred policies of this president.
So there is no science possible in managing these two variables, just beliefs applied under the guise of "rational" intervention.
Maybe if we had more trust in Mother Nature and the Invisible Hand, not to mention the entrepreneurial creativity of those Americans who haven't lost their willingness to sacrifice and work hard for a better future, we would be doing better.
The drop of the stock market has probably been amplified by the low interest rates the Fed has kept for six years, and at least to me it signals very dangerous ground ahead.
The low interest rates have resulted in unusual levels of leveraging, so high that even Fed Chairwoman Yellen has recognized their existence, although she claims they sill don't represent a danger. I beg to differ.
Those unusually high levels of leveraging can lead to a rapid unwinding, which is what I think is what may be making investors nervous, that in turn can throw the economy into another recession.
We are about due for another downturn of the business cycle anyway, and all factors combined can make this next one another real bad one.
There is also an alternate explanation. If you look at the public debt trend over the past three years, it matches almost perfectly with the stock market growth. The debt ceiling was hit back in mid-March, roughly the exact same time the markets flattened out. We had an identical flat line period in 2013 when the debt ceiling was hit for months prior to the debt ceiling circus in October 2013.
U.S. Treasuries are the primary source of driving new cash into the market and since the Treasury is no longer allowed to engage in additional borrowing, all the new money flowing into the stock markets has been cut off, so the growth in prices ceased and is starting to head downward without all the cheap money flooding the system.