Examining the global crack-up boom: Part I

Since the 2008 financial crisis central banks around the world have created in excess of $12 trillion. Not only has their policy of ultra-lose money created another unsustainable boom in asset prices, it is looking increasingly likely that it will end in what Austrian economist Ludwig von Mises called a “crack-up boom”, i.e. a complete breakdown of the monetary system.

Inflation: The curse not the cure

The following is a paragraph from the book Human Action: A Treatise on Economics by Austrian economist and philosopher Ludwig von Mises:

“It is asserted that mankind would not have reached its present state of well-being if the supply of money had not increased to a greater extent than the demand for money. The resulting fall in purchasing power, it is said, was a necessary condition of economic progress. The intensification of the division of labor and the continuous growth of capital accumulation, which have centupled the productivity of labor, could ensue only in a world of progressive price rises. Inflation creates prosperity and wealth; deflation distress and economic decay.”

This view that inflation, which results in a loss of purchasing power, is a necessary and desirable ingredient of economic progress is as prevalent today as it was when Mises published his groundbreaking work in 1949.

In chapter 18 Mises debunked this view, pointing out that, “From its very beginnings economics has shown again and again that assertions concerning the alleged blessings of an abundance of money and the alleged disasters of a scarcity of money are the outcome of crass errors in reasoning.”

Mises, who was in favor of limited government and a free society, made the case that “Economics recommends neither inflationary nor deflationary policy. It does not urge the governments to tamper with the market’s choice of a medium of exchange. It establishes only the following truths:

  1. By committing itself to an inflationary or deflationary policy a government does not promote the public welfare, the commonweal, or the interests of the whole nation. It merely favors one or several groups of the population at the expense of other groups.
  2. It is impossible to know in advance which group will be favored by a definite inflationary or deflationary measure and to what extent. These effects depend on the whole complex of the market data involved. They also depend largely on the speed of the inflationary or deflationary movements and may be completely reversed with the progress of these movements.
  3. At any rate, a monetary expansion results in misinvestment of capital and overconsumption. It leaves the nation as a whole poorer, not richer.
  4. Continued inflation must finally end in the crack-up boom, the complete breakdown of the currency system.
  5. Deflationary policy is costly for the treasury and unpopular with the masses. But inflationary policy is a boon for the treasury and very popular with the ignorant. Practically, the danger of deflation is but slight and the danger of inflation tremendous.”

Where are we now?

The two-decade inflationary boom that preceded the 2008 financial crisis, should have been followed by a deflationary bust that would have served to liquidate the excess debt and cleanse the malinvestment. However, given the magnitude of the boom, which was fuelled by low interest rates and easy money, a bust on the scale of the Great Depression could not be tolerated. Instead, governments, via their central banks, slashed interest rates and engaged in massive money printing (QE).

Since 2008, central banks around the world have created in excess of $12 trillion, however this ultra-lose monetary policy has not yet resulted in a new period of economic boom, nor has it triggered a sharp rise in consumer prices (CPI). In fact, all this newly created money has barely been enough to offset the deflationary force of debt deleveraging.

What this newly created money has done however, is create a boom in asset prices. Stocks and bonds are both at, or near, all-time highs, and other markets such as residential property, art, wine and classic cars are all witnessing extreme valuations that are reminiscent of 2007/08.

Inflating new asset bubbles

As Bill Gross, founder and co-chief investment officer of PIMCO noted in a recent interview, “We see bubbles everywhere. That’s not to be dramatic, and that’s not to suggest that they will pop immediately. I just suggested in the bond market with the bubble in Treasuries and the bubble in narrow credit spreads and high yield prices that perhaps there’s a significant distortion there.” He also sees emerging bubbles in the stock market and real estate.

On Friday Art Cashin, Director of Floor Operations for UBS Financial Services & CNBC Market Commentator, noted that, “We’ve taken the market to areas that use to be considered extreme. The S&P 500 is selling at a 25% premium to its 200-week moving average”, and “the number of stocks that have reached new yearly 52-week highs, there at a 35 year high going back into the 80’s.”

Art also noted that money managers whose investment approach relies on macro indicators are having a really hard time. They look at “things like GDP, overall non-farm payrolls, overall employment (cash going into hands to be spent). If you look at the average work week and then take a look at the dip in payroll wages… it looks as though workers are working more hours and earning less… and if I blindfolded you, or any classical economist, if I blindfolded Milton Friedman, and read him all that list of macro numbers and asked him where did he think the Dow or the S&P would be, it would never be at this level, and that is why people are calling this the ‘most hated rally ever’.”

Jeffrey Saut, Chief Investment Strategist for Raymond James, also noted recently that, “This buying stampede in stocks is now 89 days in length, which is historic. This one has gone 89 sessions as of today. The next longest one before that was the 53 session buying stampede in 2010. The longest one before that was the 38 session buying stampede in 1987 that marched itself up into the August high, and we all know what happened after that. This is like nothing I’ve ever seen, and I’ve been in this business almost 43 years.”

Read Examining the global crack-up boom: Part II.

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