Economic Evolution Makes Many Comparisons Obsolete

With the passage of time, things change and evolve. This transformation can be seen in both society and the economy. Over the decades we have moved from an agricultural based society to an industrial centered manufacturing way of making a living. Now, without a doubt, we are moving solidly in the direction of technology becoming the main driver of cultural change and with it, the economy is again undergoing a metamorphosis. With the passage of time, we tend to forget or minimize in our minds what is too painful to remember and the way we were during times where growing pains battered us at every point. While we are undergoing this latest transformation and all the noise that accompanying it I ask you to consider the possibility the important adjustments the economy must make are lagging far behind our current “financial culture” or that the economy has evolved in a way that simply no longer works.

The Titanic Was Herald As “Unsinkable”

Much of this has yet to become apparent to the masses and is masked by institutions papering over problems and a tradition of optimism that has served mankind well, however, something seems to be broken or out of kilter. When we look behind the curtain it is difficult to ignore the numbers simply do not work going forward. Ignoring the warning signs on the horizon does not make them go away and kicking the can down the road can only delay the inevitable for so long. Many of the comments I read concerning the current stock market and companies such as Tesla and Amazon remind me of the following statement, “Not even God himself could sink this ship.” that an employee of the White Star Line made during the launch of the Titanic on May 31, 1911.  The truth is as we move forward we are in uncharted waters at any time a surprise might shock us into the reality.

Much of the economic distortions we are experiencing today harken back to President Richard Nixon’s decision on August 15, 1971, to close the gold window. It is a factor that changed everything. While US citizens had been forbidden from owning gold or from redeeming their gold certificates for gold coins since the early 1930s, foreign governments still had the privilege of redeeming their dollars for gold. Nixon’s decision untethering the dollar from gold and releasing it from the promise dollars could be redeemed in gold, this resulted in opening the floodgates and allowed credit to explode from $1.7 trillion to $65.5 trillion at the end of 2015.

total-credit-market-debt3
Exploding Credit Has Massive Ramifications

A question we must ask is just how relevant today’s comparisons are with prior economic cycles? The situation today is in many ways “historically unique” due to the rampant expansion of credit in recent decades. Much of this has flowed from Nixon’s decision to close the gold window and may be greatly responsible for the rising income inequality that has occurred in recent decades. After inflation soared in the late 70s America found the cost inflation in goods could be reduced by buying these things from low-cost producers located in other countries. This means imports soared.

A de facto policy of placing no restraints on trade deficits due to the removal of the gold window has encouraged the outsourcing of jobs. This policy dovetailed with America’s decision decades ago to make China into a formidable ally that would act as a  counterbalance against Russia and the Kremlin. We did this by offering economic incentives and help to China’s economy, looking back this was a watershed event which changed the way American companies conducted business. It has resulted in American companies outsourcing production and the mass exodus of manufacturing jobs from America to distant lands where labor was both cheap and abundant. This policy was sold to America’s middle-class as a “win-win situation” and we were told the American worker would move up the economic food chain towards better-paying jobs that would be more fulfilling and require less toil. This did not happen.

Many Comparisons With The Past Now Obsolete

Returning to the main theme of this article this massive expansion has rendered many comparisons with the past obsolete. It has also resulted in the economy embarking on a rollercoaster-like experience where it encountered a series of events such as the dot-com bubble, which burst in 2001. In reaction, the Greenspan Fed stepped on the gas blowing the biggest housing bubble on record. In response to that asset bubble popping, we saw the Fed bail out the banks, the asset holders and the wealthy. The bottom-line is that in the end, this chain of events left the average American worse off than before. During all this time debt has grown, and to service that growing pile of debt the Fed had to keep slashing interest rates. This means that instead of allowing consumers to benefit from technological advances that tend to be inherently deflationary, the Fed sought to increase inflation by declaring inflation in the range of  2% to be in our best interest. This has benefited the banks and those already wealthy while at the same time increased inequality.

I came back to finish this article that I started some time ago because I found myself pondering the line, “outwit and outlast” that is often used during the popular hit television show Survivor. It occurred to me the winners in both life and investing often reflect these qualities and that this game is far from over. While investors are often urged to be cautious the excesses of today are in many ways not as “sector” oriented as those experienced during certain periods we have seen in the past and this makes it more difficult. It seems everything is encouraging and causing both savers and investors to take far more risk than they should in the quest for higher returns and yields. The “fear of missing” out is again running rampant and with the strategy of buying the dip having proven successful over almost a decade investors have become complacent to the risk they face.

H/T: Bruce Wilds


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