Updated: Sep 14, 2020
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Is the economy "better than its ever been" as the president claims or are we in a deep recessionary cycle caused by Federal Reserve interference and the reliance on cheap credit?
As the elections get closer we can expect to see arguments from both sides about the health of the economy. Republicans will try and blame the state of the economy on the virus and the democrats will blame poor policy response from the white house. Republicans will point to a strong stock market as an indicator of economic health, which is inherently flawed. Democrats will say that the stimulus to main street is what saved the economy, which is wrong. regardless of what either side says; just remember that we are still going to be in a recession during election season.
Our argument is that the economy was headed for a collapse with or without the virus. The underlying fundamentals were inherently negative and were due to burst. The stimulus added by the government has not only pushed off this crisis but will also create the largest bubble in economic history. We will explore these reasons in further detail. The second wave of the virus will play a substantial role in the health of the economy.
The most important aspect of economic crashes is the policy response from regulators/governments. The current U.S administration ran on the premise of reducing the government budget, lowering taxes, and reducing the inflationary role of the Federal reserve. What we now see is the largest stimulus plan that has ever been implemented. The PPE and CARES act programs will cost a total of $2 Trillion to the U.S Taxpayer. Of course, it won't be financed by the tax payer today, instead they will leverage the help of the Federal reserve for quick cash and put the cost on the future generations to deal with. Along with fiscal stimulus the Fed has pledge almost a Trillion dollars to help maintain the credit markets, further adding to the size of the Fed's balance sheet.
Stimulus: A thing/action that promotes activity or energy in someone or something; a spur or incentive.
Credit: The ability for an entity to obtain goods or services before payment, based on the trust that payment will be made in the future. (Debt)
CARES Act: A bill that was passed as part of the Corona Virus relief fund which provides immediate financial assistance to those who need it.
Federal Reserve Balance Sheet: Like any business organization, the Federal Reserve maintains a balance sheet showing its assets and liabilities. During economic crises, the Fed can expand its balance sheet by buying more assets, such as with quantitative easing (QE).
Asset Bubbles: Occurs when the price of an asset, such as stocks, bonds, real estate, or commodities, rises at a rapid pace without underlying fundamentals, such as equally fast-rising demand, to justify the price spike.
History of Policy responses to market failures:
Its important to understand markets so that this situation can be clear. Ever since the first markets were around there have existed bubbles (Tulip Mania). Bubbles are a natural part of the economic self correction process. They are supposed to re-balance supply and demand while simultaneously cleaning out all of the unproductive parts of the economy.
The role of bubbles has now been self perpetuated because of central bank policy. Instead of natural bubbles being allowed to form and burst in an organic way; the government has stepped in and provided stimulus every time, pushing off the bubble and making it larger; while creating a convenient 10 year window between these bubbles.
The premise behind this is that if bubbles are going to happen regardless then it would be better for the Fed to control them and make them more predictable. They believe if the government can flood the markets with cash then borrowers can go out and lend to other borrowers and stimulate the economy.
The reality is that corporations and banks have always taken the money and bought back their own stock to increase their share of the company. What this has led to is a perfect correlation between the federal reserve action and stock market recovery.
What this leads us to conclude is that the current rise in U.S. indices is not due to optimism about the future and is certainly not representative of economic health. Instead it is representative of Federal Reserve printing money and that same credit getting locked into the equity markets. This means that the stock market has now become a better gauge of the wealth of the rich as oppose to the health of the Main Street investor.
What comes next?
The euphoria is at an all time high in the equity markets. Credit dependent companies and banks have responded predictably to the monetary stimulus. The stock market bubble is only get exasperated by the recycling of government credit. Could this mean that the stock market could collapse in the U.S if the government stops printing money? Could this mean that breakout traders are going to get burned by the economic reality of the situation? Or will the high of having cheap credit cure the withdrawal long enough to make the economy recover?
Its easiest to compare the economy to a sick person. Instead of this sick person changing their diet, doing rehab, and taking the long road; we've opted for the opiates every time. 2008 was the result of the stimulus that the government printed in response to the .com bubble. We took pain meds in '01 to avoid doing the hard work. The system crashed from the center in '08 (Wall street) and instead of letting the body finally heal itself we pumped it with even more pain meds. Now its 2019-2020 and we're having withdrawals from the cheap credit.
The second wave of the Corona virus may bring markets back to reality by exposing how deep the recession really is.
As a result of overinflated asset prices we can expect to see some of the air come out of the stock market bubble. S&P500 prices should see a decline back to normalcy so as to reflect the health of the equity markets.
Due to the unlimited printing of free dollars we can expect to see a crash in the value of the United States Dollar and a rapid rise in the price of Gold.
Since gold is valued in terms of dollars; the lower the price of the dollar the higher the price of Gold should be.
Disclaimer: This article is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice.
ChartAddicts Analysis Team