Can a Market Crash Save Us from Hyperinflation? 20 comments
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I have a very strong suspicion that this is going to be a very unpopular article. No one likes it when the market falls. A stock market crash evokes images of the Great Depression, but the reality is that history never repeats itself exactly. When the S&P 500 (SPY) broke below the 200 day moving average last week, given the fundamentals of an economy in deep trouble, a lot of economists were shivering in their boots. People assume that whenever share prices go down, the event is bad for the economy.
But, what if the market does collapse? What if it really does breaks below the previous lows? Will that be bad...or could it be good for the economy?
There is an increasing chance that the indexes will retest March lows. Speculators (and quite possibly, the Federal Reserve and its PPT banks) are buying heavily, but insiders in almost all industries are vigorously selling stock. Heavy insider selling is usually a sign of things to come.
A falling stock market can be hazardous to the financial health of speculators who are operating on margin. It can temporarily shrink the 401K retirement funds of millions of Americans. But, a falling stock market need not be bad news for the economy in the long run. Indeed, it may be just what the doctor ordered. Smart investors will always welcome falling share prices, when they have cash to buy, because it gives them the opportunity to buy stocks at low prices. But, the most important thing is that, if the stock market falls, it will assist the U.S. dollar in recovering lost value.
Rising stock markets are now associated with a falling dollar, and they impair the ability of the U.S. government to sell Treasury bonds at a reasonable rate of interest. The government desperately needs to sell bonds, right now, because trillions of dollars have been earmarked for huge corporate bailouts. These bailouts are the lynchpin of the Bush/Obama legacy. Whatever money the government cannot borrow, to pay for these bailouts, it will surely simply print, and that will be devastating.
Without the ability to borrow cheaply, America will be default overtly, or, more likely, covertly, through hyperinflation. Also, rising rates on long term debt, which is to a large extent determined by the yield on long term Treasuries, will surely suffocate any hopes of a housing recovery. The government has done a lot of stupid things.
The Federal Reserve and U.S. Treasury have attempted to micro-manage the economy for years, for one thing. For another, crony capitalist bailouts do not tend to create long term economic strength. It would have been better to allow the investment banks to fail, better to have paid off or sold off the deposits of true banks through the FDIC, and better to have allowed irresponsible counterparties to high-risk transactions, like Goldman Sachs (GS), to suffer the consequences.
Instead of suffering consequences, we have seen an unprecedented increase in moral hazard, as incompetents on Wall Street, through the medium of AIG and other bailouts, now receive record bonus payments.
But, like it or not, the U.S. government, and by extension, all Americans, are now on the hook for trillions of dollars. We must either tax ourselves into oblivion, print money, or sell bonds at favorable interest rates. The bond selling route is the best of three bad options.
The connection between a rising market and a falling dollar probably has a lot to do with the U.S. Federal Reserve. It has added huge amounts of so-called “liquidity” to the banking system. Most of this money has not found its way into the hands of any business that has a productive use for it. Most businesses are not inclined to borrow in recessionary times, when they are shrinking.
So, the liquidity injections find their way mostly to investment banks. These banks use the money to buy stocks and commodities, or to make margin loans to hedge funds and other players, who do the same thing.
Investment banks, awash with liquidity, bid up stock and commodity prices. They pay for this in Federal Reserve Note dollars, and that increases the number of dollars in circulation, reducing the value of each one. The cycle then becomes self-reinforcing. Speculators choose to own stocks, gold, silver, oil, coal, iron, copper, and other non-dollar items instead of dollars or bonds. Industrial inputs and consumer goods become more expensive, not because there is more demand, but, rather, because there is more speculation.
When stocks and commodities go up in the midst of a depression, financial speculators at investment banks and hedge funds win. Productive businesses and consumers lose. Gasoline is an excellent example. High gasoline prices are once again putting pressure on the consumer pocketbook. This will eventually have a poisonous effect on retail sales, going forward.
With the exception of Canada, we have few true friends in the oil exporting business. The higher price for oil transfers tens of billions of dollars to generally unfriendly places, like the Arab Middle East, Iran, Russia and Venezuela, some of whom will use those dollars quietly, or not so quietly, to support terrorist groups.
Increased inflationary expectations increase bond yields, and cause the dollar to fall. For example, in mid March, when the rally started, bond yields were beginning to rise. In an effort to damp down long term interest rates, the U.S. Federal Reserve pledged to buy up to a huge $300 billion worth.
Although heralded as a move that would tame bond yields, it has been completely ineffective and, after an initial honeymoon, monetizing the national debt has had exactly the opposite effect. The reason is that when the government buys its own bonds, people begin to fear runaway inflation. The 10 year bond yield recently rose almost 4%. It has since fallen to about 3.5%, but that is still much higher than where it started.
Physics tells us that infinity and zero are simply two ends of the same straight line that goes on forever. If the Fed buys unlimited numbers of bonds, such bonds would eventually need to pay a nearly infinite yield, because, to anyone other than the Fed, the value of such bonds will reach absolute zero.
Thankfully, in spite of strong pressure from many self-interested persons on Wall Street, the FOMC finally found some discipline, and didn't increase the ill thought out program. As a result, bond yields have fallen somewhat, since. Hopefully, they will end their so-called "quantitative easing", at the next meeting, or sooner. Making that announcement would do a world of good for the value of the U.S. dollar.
Rising stock markets, in the midst of economic depression, may well be the creation of the "expectations managers" at the New York branch of the Federal Reserve. The Fed can easily induce an artificial share price rally by heavily buying stock index futures from derivatives dealers, so long as it is willing to print enough money to pay for them. Arbitragers then even out the difference between the cash market and the value of these futures, and the process would have a net effect of forcing the stock indexes upward. The newly printed dollars, flooded into the system, through the derivatives dealers, would cause the U.S. dollar to lose value, however.
That may be the most logical explanation as to why the dollar has fallen so far so fast, even though we are having a "rally" that, if based upon strong economic fundamentals, should ordinarily cause the dollar to rise.
There are many possible reasons why higher share prices are now linked to a lower dollar. One thing, however, is clear. The only way to induce foreigners to continue to buy dollars and dollar based derivatives (bonds), is to make sure the U.S. dollar is not a perpetually falling currency. They will not permanently continue to buy Treasury bonds, denominated in a falling currency, which pay extremely low interest rates.
If the stock market is allowed to fall, and the dollar given a chance to recover, long term Treasury yields can fall, commodity prices can moderate, and both the government and potential home buyers can successfully navigate capital markets.
Assuming the alleged “stimulus” is really ever going to work, the stock market will eventually rise again. For long term investors, who don't indulge in margin based speculations, a falling stock market will be provide some painful portfolio views, but will increase the value of their portfolio in the long run.
Hopefully, before the market rises again, however, the U.S. government will, at least, have finished selling this year's allotment of bonds.
Disclosure: No positions on any stock or bond mentioned in the article.
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This article has 20 comments:
The falling stock market last year which gave us such low rates also gave us a 2T dollar deficit. If the market falls again like it did last year, the deficit next year will be LARGER than 2T which would make hyperinflation more likely...not less likely.
No matter what happens (save the miracle of lower gov't spending) rates are going to eventually go up.
On what grounds do you assume any such thing?
You have ably laid out that in practise stimulus money has been diverted to speculation, which is hardly going to lead to economic recovery.
As soon as the world economy actually does get going, and there is no sign of that for the foreseeable future, then lack of investment in oil reserves will lead to a price spike, smashing the recovery.
Even in China it is becoming obvious that most of their stimulus is leaking into commodity speculation, so there is little chance of help from there.
The loss of value behind stock prices is real and absolute, and based on miss-allocation of capital to assets which will never provide a return, with commercial property in malls which will stand empty being the most obvious example.
Sure, in some sense the stock market will 'rebound', in the sense that values may recover, but we are talking decades, not years, and the recovery will be based on new investment in assets which are actually productive, not a rediscovery of value in present assets, which are, as they appear, worthless.
Of course, none of this tells us what the stock market will do in nominal terms, only in it's buying power of real assets.
Inflation may hit such heights that the nominal price of stocks rises, but the underlying value will still sink.
People's 401's are trash, because they were invested in worthless assets.
Recovery will happen, but only in the sense that a bankrupt restaurant owner walks away from the property and starts doing something else, not one based on the value of existing assets.
At the moment the economy is in the same stage as the restaurant owner prior to foreclosure, hanging on and hoping the business will turn around.
It won't.
The author is right that a collapse of the economy will stall devaluation because once again equity will be wiped out en masse. Unfortunately, maybe then government spending will then rise from 12.5% of GDP to 20%. Thus a correction is only good if it also includes a collapse in government spending (usually the inefficient part of our economy).
Conversely, as long as deficits and government spending keeps rising and liquidity and public spending/keep falling even if the stock market rises, our futures will not look brighter. Government fueled recoveries are not real recoveries at all.
On Jun 30 03:52 AM Egg wrote:
> Ok, what about next year's bonds? And the next year's after that?
> And so on and so on?
Someone please send this note to Ben, Tim, n Obama!!!!
It may be unpopular, but it is the most sane thing to do!
Yeah Right!
The only circuit breaker that could possibly work (a big IF) is slashing govt. expenditure and the deficit. Very very unlikely in my view hence we are the fast track to hyper inflation. Look around you and it's easy to come to the conclusion we are already on the path.
NB: the only govt. in the world that is doing something like this is New Zealand. Unfortunately for them their $$ is appreciating and killing any chance of export led recovery. It's pretty hopeless for everyone really.
Building a base from the rise off of that unwarranted low is what is good for the economy right now. There is no inflation and any that appears will come from speculators manipulating the dollar and therefore oil... and NOT from any real economic reality.
Stopping the dollar falling once it has reached fair value, however, might just have something to do with controlling the circulation of dollars. To stablisise the dollar and enhance its status means to stop printing.
Yes, American in general including the government has overspent. The consumer is being a little contrite these days, but they Government is just going on one bender after another. When corporations are insolvent they go into judicial adminstration and the CEO is generally removed. I think this is what is required in the case of the US Government.
I vote for option 4. Govt quit spending!!!!!
Simple common sense.
The market is the wheel of the economy but political expedience is the grease that set the direction the wheel will roll.
Your article is correct in every way but the politicos have masters to serve
1. The Fed lends money to investment banks (mostly member banks like Goldman Sachs) who bid up stock prices.
2. As the market gets toppy, the Fed's Plunge Protection Team intervenes to buy stock index futures, helping the investment banks unload stocks at a profit.
3. The investment banks make further income from arbitrage trade between the futures and stock prices.
4. Let's not forget naked short selling, which allows these crooks to drive competitors like Bear Stearns and Lehman Brothers out of business as well as allowing them to profit from the destruction of American companies, jobs, and wealth.
5. If any of the investment banks' trades go bad, they blackmail the Congress and the American public by threatening to drive stocks to new lows if they do not get trillions of dollars in bailout money.
This is financial terrorism, plain and simple.
I will say I've got a problem with the term "hyperinflation". To me, that brings to mind the old pictures from the Weimar Republic of people going to the grocery store, pushing a wheelbarrow filled with banknotes, or the situation in Zimbabwe, where currency was simply "re-printed", with the old denomination struck out, and a new, much higher one added. I'm not convinced things would/could get that bad, but something in the range of 10-15% annual inflation would be bad enough.
donnie
Lone Rock, Wisconsin
I agree with you. Rotten fish...smells like Hank Paulson in the morning....Alan Greenspan in the evening....
On Jun 30 02:00 PM Genesis wrote:
> Reading between the lines, it's easy to spot a "rat" here.
>
> 1. The Fed lends money to investment banks (mostly member banks like
> Goldman Sachs) who bid up stock prices.
>
> 2. As the market gets toppy, the Fed's Plunge Protection Team intervenes
> to buy stock index futures, helping the investment banks unload stocks
> at a profit.
>
> 3. The investment banks make further income from arbitrage trade
> between the futures and stock prices.
>
> 4. Let's not forget naked short selling, which allows these crooks
> to drive competitors like Bear Stearns and Lehman Brothers out of
> business as well as allowing them to profit from the destruction
> of American companies, jobs, and wealth.
>
> 5. If any of the investment banks' trades go bad, they blackmail
> the Congress and the American public by threatening to drive stocks
> to new lows if they do not get trillions of dollars in bailout money.
>
>
> This is financial terrorism, plain and simple.
Are you having a laugh?
Selling more debt will inhibit economic recovery and broaden the downturn. Future tax levies will need to be increased to pay down the growing deficit. This is akin to taking out a HELOC loan to make your monthly mortgage payment - the hole is getting deeper at an even faster rate.
A far better solution would be to dramatically cut government expenditures and income tax rates. This would allow the private sector to repair their business and personal balance sheets by paying down their debts and increasing savings. This newly accumulated capital could then be invested in future productive efforts.
Just remember: 1) Debts ALWAYS get paid off...but not always by the debtor...and 2) the Baby Boomers (the worst generational pollution our nation has ever suffered) will get their 'equity' just like they always get everything else they have ever demanded -- through sheer market/political clout in demographic numbers.
Hyperinflation is coming, kiddies. Anybody who wants to claim otherwise needs to logically disprove aforementioned points 1 & 2, thank you very much.
Oh, and the BS "that's just cynical!" does not constitute a logical statement that disproves either one of those two points, which are established in actual historical accuracy.
It's a CRIME what the Baby Boomers have done to the standard of living for future generations. If you did these same things to, say, a puppy, you'd be in jail. You old people just need to DIE!