The “Sugar-Rush” Economy
It’s useful to think of the economy as we’ve known it as the “sugar-rush economy.” Allow me to explain.
Scientific research indicates that heavy doses of refined sugar may impact the human brain in a manner similar to addictive drugs. Stanford professor and neuroscientist Eric Stice has run experiments using MRI scans to study how our brains respond to sweetness. Consuming sugar releases dopamine, the brain’s “reward” chemical. The impact is similar to that of cocaine and other addictive drugs.
After scanning hundreds of volunteers, Stice concluded that heavy sugar consumers steadily build up a tolerance. The result: One must consume more and more sugar to release the same amount of dopamine. This process dampens the “reward center” of your brain in response to food.
The rising tolerance of the human brain to drugs (or sugar) mirrors how economies can build up a tolerance to government deficits and central bank stimulus. Balanced budgets and shrinking money supplies would bring about withdrawal symptoms that crash the economy.
So in order to maintain the status quo, the prescription is more drugs, more sugar, more spending and money printing. And if the effect starts to wane and withdrawal symptoms appear, the economists running policy predictably say, “Double the dose!”
Bubble-driven economies build up a tolerance for ever-higher doses of money and credit. The “Austrian” School of economics warns that once economies fall into addiction, the long-term consequences are tragic: either a deflationary collapse or hyperinflation. I agree with that assessment.
An alternative path might be a policy that proactively weans the system from addiction, but such a policy is politically impossible these days.
The Federal Reserve, along with every other central bank, has for the past decade been trying to prop up an unstable mountain of debt while simultaneously avoiding the collapse of confidence in their currencies.
The Fed’s rate hikes in 2017 and 2018 were partly to rebuild confidence in the dollar. Nothing builds confidence in paper money like being able to earn a positive real interest rate while holding it on deposit.
But we know how that confidence-building exercise ended at the end of 2018. The Fed retreated at the first sign of adversity and went right back to placating the financial system tantrum with sugar.
Interest rates on U.S. dollar bank deposits and Treasury bills were above zero for such a short period of time that the economic system barely had any time to get used to it. Now we face the prospect of zero interest rates for years into the future.
That might sound good if you are a borrower, but don’t forget that there’s a lender on the other side of the transaction. And in today’s economy, lenders employ many Americans and earn interest that’s passed on to pensioners. There are clear consequences to endless zero rates, as Japan’s financial system has shown everyone.
The Fed was in a difficult balancing act over the entirety of the post-2008 economic recovery. Now throw in the radical uncertainty of the economic ripple effects of the coronavirus and it’s become near-impossible for central banks to deliver an outcome that’s pleasant for investors.
Here’s a very important lesson of our debt-addicted system, one that doesn’t bode well for the future:
When an economy’s debt grows, it transfers what would have been future economic activity into the present. So it’s reasonable to assume that because the stock of global debt soared over the past decade, a large amount of production and consumption activity was pulled from the future to the present.
If the Fed’s balance sheet swells in size to $10 trillion or $20 trillion, it won’t make consumers more likely to borrow more money if they don’t want to borrow.
Even worse, from the Fed’s perspective, would be if consumers and companies go into balance sheet repair mode and pay down debt. That acts to transfer income earned today to pay for the purchases made yesterday on credit. From the Fed’s perspective, that behavior is like “anti-stimulus.”
But if consumers are offered zero interest on saving money and are still paying interest on their debt, can you blame them if they choose to pay down debts with the stimulus checks that will be mailed out in the weeks ahead?
If you think about the time-shifting nature of debt accumulation, this is the essence of how central banks supposedly stimulate economies. It simply scrambles everyone’s time preferences and robs the future, leading to bad decisions. It’s all very short-term.
The transfer of future economic activity into the present carries with it the problems we saw during the U.S. housing bubble: The borrowed-against future eventually arrives and brings with it a collapse in demand for the already-bought items.
Consider the spike and crash in U.S. new home construction. When single-family housing starts peaked at a 1.6 million annual rate in early 2006, several years’ worth of future demand was pulled into the present.
Low mortgage rates and lapsed underwriting standards caused years’ worth of demand to be constructed and delivered in a single year. The bust ruined millions of homebuyers’ credit scores, keeping them out of the market for years to come.
It took until 2012 to see a renewed uptrend in housing construction, and even now, despite favorable U.S. homeowner demographics, the level of starts is still 33% below the 2006 peak.
Such are the consequences of promoting bubbles. Wouldn’t it be better to not have bubbles in the first place?
You would think, but central bankers always seem to think they can keep everything in check.
Their goal of targeting a precise level of inflation expectations for future inflation, as though the economy were a thermostat, is not realistic.
Pursuing this goal creates more problems than it supposedly solves. Pushing consumers and businesses to buy today with the expectation of higher prices in the future is hardly different from promoting the wild growth in debt-driven housing activity in 2004–07.
The Fed’s money printing experiments infuse sugar rushes into the natural pace of economic activity, followed by hangovers.
This rush-hangover-rush-hangover cycle is a result of crony capitalism and central banking; it’s not the result of real capitalism. This system has resulted in fragile balance sheets at both the corporate and household level.
This brings me to corporate profit margins and how they are at risk in an economy fueled by the sugar rushes of federal deficits and money printing.
A private sector that once operated on a diet of healthy foods now lives from one sugar rush to the next. Deficits and money printing have degraded the health of most businesses.
Rather than live on the steady nourishment of savings and capital investment, more and more company leaders have resorted to short-term gimmicks to hold onto their executive titles and board seats.
A big gimmick was the wave of unaffordable stock buybacks and dividends we’ve seen over the past decade.
Rare is the company that produces so much excess cash so consistently that it can afford ever-rising distributions of cash to shareholders. Companies that can only afford to return cash to shareholders under favorable conditions (this describes most companies) wind up with little in reserve during lean times.
They discover that they squandered resources when some catalyst like the coronavirus comes along and they wish they still had the cash that they wasted on stock buybacks.
But they don’t have it. And they want to be bailed out for their errors. Again, that’s not capitalism. It’s crony capitalism.
And we’ll all be paying for it.
for The Daily Reckoning