The Crack-Up Boom
How long will we live in this state of denial? I don’t mean you. I mean most people. Yes, people are grumbling about high gas and food prices, But we are not yet at the panic stage. For goodness’ sake, the president of the United States warned about coming food shortages. If he had any credibility at all, there would have been a run on grocery stores.
This didn’t happen for three reasons.
First, people do not take Biden seriously. He seems not to know this. He continues to pronounce at press conferences in ways that seem almost crazy, like he doesn’t know that he is no longer believable.
Second, Americans have lived 40 years with relatively predictable supplies and prices. At this point, it is baked into how we think and behave.
Third, there seems to be a widespread assumption that these price increases are temporary and will settle down to the old normal at some point.
The reality is that all the current price increases are permanent. The Fed has no ability to bring them back down, even if the Fed had the desire to do so. The measure of inflation, called personal consumption expenditures, just reached a 40-year high. And the momentum of change seems entirely with higher prices throughout the year. By year’s end, we could inhabit an extremely unfamiliar economic environment.
There is no question that the pace of inflation has blindsided the Fed, which was predicting 2% this time last year. How could they not have seen this coming? The M2 money supply is up 42% in two years. Is there really no one involved at the highest levels who understands the relationship between money supply and prices?
The state of denial dates back to 2008. Last time there was a huge crisis and the Fed unleashed monetary expansion on a dramatic scale, it observed continued downward pressure on prices. That was contrary to many predictions, among which my own. What I had not anticipated was the advent of a new policy. The Fed actually paid banks — and did for many years — a higher return for holding assets in the system rather than releasing them. This kept hot money off the streets.
Why did the Fed do this? Because the entire point of the policy was to re-capitalize the banking system. There was no great macroeconomic agenda. The Fed wanted to save the system from collapse. That it did. And it did it with newly created money that never landed in the hands of producers or consumers. The entire event ended up a vast exercise in financial cosmetics. The markets loved it.
The expansions of 2020 and 2021 were entirely different. Congress spent money it did not have. Trillions and trillions. That spending was debt financed. The Fed stepped up to buy the debt. The money was dropped directly into bank accounts of both businesses and consumers. It became very hot. The Fed felt it had no real choice. It pointed to Congress as the culprit. It merely responded to the wishes of government, and that’s true to a point. Regardless, that was not without consequences.
You just can’t get away with something on that scale forever. The great “Austrian School” economist Ludwig von Mises in the 1930s fleshed out his theory of the business cycle in great detail. He demonstrated that the distortions we see with credit expansion go way beyond steady price increases. The new money distorts all the signals in the market leading to a mismatch between production and consumption. This creates the conditions that lead to the economic bust.
At this point in the cycle, what happens next is determined by the central bank’s response. If the central bank is determined to avoid recession, it will lean in with more monetary expansion, leading to ever more rapid price increases. Hyperinflation hits. The recession and then depression happen anyway. This threatens the integrity of the money itself, as people more and more flee paper for goods.
This process leads to the most feared event in 20th century economic history: the crack-up boom. There is a shortage of money even as production collapses, leading to goods shortages.
The very possibility of such a thing in the U.S. was essentially unthinkable in 2019. But then the lockdowns happened, and the preposterous decision by Congress and the Fed to game the whole system with fake money and massive spending. There is always a lag to the effects of such things, typically running 18 months. We are past this point, so what we are seeing right now is entirely predictable.
The Fed is acting like a hawk right now but if you listen to the language it is using, the rate increases are solely designed to tamper down inflation. There is still a strong intention in place to avoid recession. What will the Fed do if recession happens anyway? It’s anyone’s guess but it strikes me that no one at the Fed or anywhere in government today has the courage to let the economy fall into recession.
Back in 2021, Ron Paul issued a strong warning that his trajectory could in fact lead to a crack-up boom. He was pretty much alone in daring to utter the words. So far his warning has proven prophetic. Even as he spoke, the Fed was still talking like this inflation would be transitory. It is far from it.
The future of prices is heavily influenced by consumer and producer behavior. If expectations are high, the fear becomes self-fulfilling. Right now, there is still vast room for inflation. The Fed is very much behind the curve at this point. No one is contemplating the kind of policies that would even attempt to suck up all the excess liquidity. It has to go somewhere.
Meanwhile, there are growing signs of recession. Mortgage rates just hit a new four-year high. The yield curve is inverting on key bonds. The timing could not be worse from a political point of view: The Biden administration will do everything possible to avoid a recession as we approach November.
There is a huge additional problem with the breakdown of trade relations both with Russia and China, and China too seems to be headed to a period of slow growth, if not recession too. Germany already faces 8% inflation, with no end in sight. This raises a remarkable prospect of a global crack-up boom. No one dares talk about it.
The Biden administration is facing all of this with some of the most dangerous budget proposals in many decades, if not ever — record-breaking tax increases plus innovating a new method of taxation: going after not only income but yields on wealth held.
You are awake to all of this, but how long will it take for average people to get hip to the dangerous realities in which we live now? We could be facing not only two decades of weak stock market returns but a weak economy.
Very few are prepared for these possibilities.
for The Daily Reckoning