The world is changing abruptly before our eyes, yet very few "professionals" see what's coming. In my opinion, this is because most financial types are equipped to understand a world that fits a very narrow framework. The world they can analyze and understand conforms to a certain paradigm; they aren't trained to see the true paradigm shifts. As long as the world resembles what they learned in Finance 101, they can do very well. When the dramatic shifts occur, they are exposed. This is a distinct advantage that people outside the system have: they can take a step back and absorb what's happening without presuming anything.
The megatrends of the future are emerging and this is truly fascinating. Conventional wisdom is being debunked, but people continue to rigidly cling to their opinions. What perhaps amuses me the most is the love affair with interest rates. Are there actually people who believe that simply lowering interest rates will reverse an economic decline decades in the making?
When the general level of confidence is high, lower interest rates can stimulate demand. I totally agree. However, people mistakenly assume that interest rates are the key variable when it is confidence that is more critical. In fact, a lack of confidence is counterracting interest rate movements right now. When confidence is weak, lowering interest rates does next to nothing besides creating a carry trade. In that case, capital is induced to invest in currencies and financial assets of foreign countries. Pretty stupid of our government, but at the same time, fairly standard government behavior.
As usual, I'll point you to the data. Mortgage rates have come down along with interest rates, and this was supposed to jump-start lending. Yet low rates have done very little to spur lending. Real estate loans continue to plummet, proving that economic orthodoxy concerning interest rates is just plain wrong.
Real Estate Loans
The economy has supposedly shifted from bearish to bullish, so obviously banks will want to participate in this economic boom and unload their excess reserves, right? Wrong. Excess reserves still stand at over $1 trillion, which was an unprecedented level before this current crisis. No confidence means no lending regardless of interest rates. Back to the drawing board Helicopter Ben.
Let's think back to the absolute peak of the panic in 2008. Companies were laying off employees and hesitant to invest in expansion. Credit tightened, so companies that wanted to expand couldn't do so anyway. When demand inevitably starts picking up again, supply is going to lag, creating inflationary pressures that have nothing to do with money supply or interest rates. The Fed will predictably react to such a situation by raising interest rates, which crudely would make the supply shocks even worse, creating even more inflation. This is just one example, but I'm just trying to provide some nuance to analysis that is often very linear.
Speculation + Inflation
One huge concern I have is that the Fed is fostering speculationas opposed to legitimate investment. There is clearly an inflationary component to funding deficits by issuing monetized debt. The realization that inflation is the inevitable outcome of the government's policies causes investors to bid up stocks. Eventually companies will be able to raise equity way too cheaply, and this will create a further misallocation of capital. And then we will see another crisis.
People need to understand that Wall Street has a very short memory. The incentive structure guarantees that people will take insane risks with other people's capital. As long as there is no adequate oversight of derivatives, speculation will run rampant. As long as market makers have proprietary trading desks, there will be a conflict of interest. There is this false sense that everything is back to normal. These sentiments will disappear in an instant.
When it comes down to it, counterarguments to my thesis are all based on false extrapolations. Munis won't default en masse because they have been relatively stable in the past 30 years. The U.S. can't default on its debt, we're the biggest economic power in the world! Pensions will only be $700 billion underfunded as long as returns match those of the past 20 years. These are all assumptions that go against the hard data.
The signs are all there. Gold is rallying in the middle of a false economic recovery. Silver is flying. Real estate is in the dumps. Government bond yields are rising. Stocks are rising. Commodities are rising. Government spending is rising. Government wages are flattening. The movement of assets are giving fair warning of what lies ahead. The time to prepare is running out because important asset correlations are really starting to materialize. It's time to buckle up for a wild ride.
Disclosure: I am long GOLD.