Fed Report Says Millennials Are Poorer Than Other Generations...But Fed Policies Made It Happen
Tue, 12/11/2018 - 20:45
Authored Ryan McMaken via The Mises Institute,
One of the challenges in looking at income and wealth data is getting a sense of how different demographic groups are affected.
It's relatively easy to find median income and wealth data over time for the entire population, for example. But then problems of interpretation immediately present themselves. For example, if the data is household data, what are we to make of things if the household compositions has changed over time?
And what if the demographics of the individuals within the households themselves have changed? For example, if a larger proportion of all households are now younger households, perhaps that could have an effect on the income and wealth data overall. After all, younger heads of household tend to have lower incomes and less wealth than older heads of households.
This problem of measuring workers and incomes over time has been the challenge that presents itself to anyone trying to figure out if so-called millennials are richer or poorer — as a group — than other age cohorts.
To do this, researches must find some way to estimate wealth and incomes for different age cohorts at similar ages or at similar points in their careers. Otherwise, characteristics we think we are attributing specifically to Millennials may really be characteristics that are just common to people of a certain age.
Last week, the Board of Governors of the Federal reserve released a new report that attempts to address the issue of whether or not Millennials really are worse off at the same point that other age cohorts have been at similar ages.
This will no doubt be the first of many that attempt to answer this question. At this early stage, however, we can say that the data leans toward concluding that yes, Millennials are, in fact, less wealthy, and are lower-income than previous cohorts.
Some conclusions in the report include:
Moreover, according to the report, "millennials also have significantly less credit card loans and miscellaneous other debt."
The problem we encounter here, though, is that the debt the Millennials do have is not connected to assets. For example, fewer Millennials have mortgages, which, given lower homeownership rates, suggests Millennials have less home equity as part of their net worth totals:
In 2004, 28 percent of Generation X members had a mortgage, well above the 19 percent share of millennials that had one in 2017. ... That said, the median mortgage balance for millennial mortgage borrowers in 2017 was somewhat higher than for Generation X mortgage borrowers in 2004 ($105,000 versus $94,000), reflecting, in part, the net in crease in real house prices during the same period.
Instead, debt seems to be more connected to student loans and to auto debt. For example:
For auto loans, contrary to the stories in the popular press th at millennials have a more subdued demand for cars than members of earlier generations, the Equifax/CCP data show that 40 percent of millennials had an auto loan in 2017, compared with 36 percent of Generation X members in 2004. The mean outstanding balances on auto loans in the two cohorts are similar at about $5,200.
And, as many suspected, student debt is higher for Millennials:
One loan category for which millennials in 2017 had a notably higher average balance than Generation X members in 2004 was student loans. While only 20 percent of Generation X members had a student loan balance in 2004, more than 33 percent of millennials had one in 2017. Moreover, the median balance among student loan borrowers was substantially higher for millennials in 2017 than for Generation X members in 2004 (over $18,000 versus $13,000). ... Accordingly, the average student loan balance for millennials in 2017 was more than double the average loan balance for Gene ration X members in 2004. The rise of student loan borrowing among young consumers reflects, in part, the rising real cost of higher education, the increase in college enrollment due to the Great Recession, and the increasingly limited capacity of parental contribution.
Thus, it's not surprising when the report concludes that Millennials have a lower net worth than other age cohorts at the same stage:
Turning to net worth, which puts together the asset and debt comparisons described above, we find that millennials in 2016 have substantially lower real net worth than earlier cohorts when they were young. In 2016, the average real net worth of millennial households was about $92,000, around 20 percent less than baby boomer households in 1989 and nearly 40 percent less than Generation X households in 2001.
The median total assets held by millennials in 2016 is significantly lower than baby boomers in 1989 and only half as big as Generation X members in 2001.
Overall, the report paints a picture of younger workers who have fewer assets, lower incomes, and more student debt.
A common response in the media has been to blame Millennials for buying "too much avocado toast," or for having too many other luxury tastes that render them incapable of building wealth. That may be true of the minority of Millennials who spend much of their lives on Instagram, but the Fed report itself concludes that the consumption patterns of Millennials are not significantly different from those of other groups when incomes and other factors are taken into account.
In other words, Millennials are not any more profligate than the Baby Boomers or Gen Xers who came before them.
The Role of Modern Monetary Policy
The report does not attempt to answer questions as to why Millennials might be unable to build wealth as quickly as those who came before. But there is something different about today's younger workers: they mostly started their careers in the post-Great Recession world and have thus lived their working lives in the shadow of what Brendan Brown calls the Great Monetary Experiment.
First of all, these workers had to deal with the fall-out of the Great Recession itself which was widespread unemployment for a period of years. This meant slower income growth in the first several years of employment, which can have a long-term effect on wealth accumulation. Economists and other observers have been pointing this out since at least 2011, when it became clear that job markets and incomes were not going to just bounce back as many assumed they would at the time. Indeed, it has only been in the past few years that most measures of incomes and wages have returned to the levels we saw back in 2007.
And Millennials appear to have been hit especially hard by this, as noted in this report from the St. Louis fed. All of this, of course, happened on the Fed's watch, and was just the latest example of how the myth of Fed-engineered economic stability has always been a myth.
So, we have a group of workers who start out their careers in a bad labor market, brought on by more than 20 years of money-pumping by Volcker (later in his term), Greenspan, and Bernanke.
But once those Millennials were able to get jobs, they then were faced with a world that was particularly hostile to saving, home purchases, and investment for lower-income workers.
Our current situation is marked by endless monetary activism marked of near-zero interest rates and asset inflation which rewards those who already own assets, and have the means to access higher-risk investment instruments that offer higher yields.
Meanwhile, banking regulations have been re-jiggered by federal politicians and regulators to favor established firms and the already-wealthy. This was explored in some detail recently by banking-industry researcher Karen Petrou who concluded that thanks to post-2007 federal regulations, "it’s basically impossible for banks to make mortgage loans to anyone but wealthy customers."
Meanwhile, basic methods of saving, like savings accounts, offer interest rates that don't even keep up with inflation.
Combine this with rapidly climbing home prices, and we have a formula for an economic system where being an ordinary worker — who needs to build wealth from scratch — is facing low yields, less accessible debt, high housing prices, and lower incomes.
This, not surprisingly, has led to greater inequality, and its likely that as we look at growing inequality statistics, part of what we're seeing is a growing gap between younger workers and older ones — a growing gap that was not as wide before.
In this environment, doing what the Baby Boomers did, or doing what the Gen Xers did, just isn't going to work very well. It may very well be that the only way for Millennials to get ahead in the current economy will need to either inherit wealth or engage in "extreme frugality" in which the Millennials will need to adopt a drastically lower standard of living compared to their elders.
This was not nearly as essential for previous generations. Of course, for those Millennials who do decide to go the route of extreme frugality, they'll then be attacked for ruining the economy by "not spending enough." The smart ones won't care.
"I Thought This Deal Was Absurd, But Pensions Are Piling In..."
ZeroHedge.com Fri, 12/07/2018 - 17:05
Authored by Simon Black via SovereignMan.com,
We have been talking about the pension crisis for years now. It’s without a doubt one of the biggest, financial disasters.
These pools of capital, responsible for paying out retirement benefits, are terribly underfunded. So anyone depending on a pension in their retirement years should seriously consider a Plan B – and sooner rather than later.
We aren’t alone in sounding the alarm on pensions.
The World Economic Forum reported that in 2015, worldwide pensions were underfunded by $70 TRILLION. That is larger than the top 20 economies in the world, combined. In the US alone, federal, state, and local government pensions are $7 trillion short on the funding they need to pay what they have promised.
And none of this includes Social Security’s almost $50 trillion of unfunded obligations.
Even the private sector isn’t in great shape. US corporate pensions are a combined $553 billion in the hole. And one quarter of those funds are expected to go broke within a decade.
Most pensions require about an 8% annual return to break even (and make all the payments they’ve promised)… historically, these funds could achieve decent returns with a mix of conservative, fixed-income investments. But after a decade of ultra-low interest rates, achieving an 8% return in bonds would be a dream.
So these pensions are forced to take on more and more risk just to break even (oh, and deal with corrupt government officials)…They’re essentially taking the teachers’ and firemen’s retirement money and betting it on black… hoping to dig themselves out of the enormous hole they’re in.
That means buying more stocks (at what may be the top of the market)… and investing in global real estate (another hugely inflated asset)… Remember, pension funds are supposed to be some of the most conservative investors on the planet. Millions of people rely on them to make prudent investments to provide them with a decent income in retirement, not to make large, risky bets hoping for outsized returns.
But pensions are desperate. And they’re swinging for the fences just to make ends meet.
Pensions have nearly doubled their allocation to real estate since 2006 (investing an extra $120 billion into the sector)
But a certain type of real estate investment called “opportunistic investments” has grown sixfold over the same period. “Opportunistic investments” is just a fancy term for being a real estate developer. In other words, pension funds are basically building spec properties now.
At least with a normal real estate investment, the funds can buy an asset and earn a reliable income stream. But now they’re buying speculative land, developing it (often taking on debt to do so) and hoping to flip it to someone at a higher price somewhere down the line.
This is wrong for so many reasons.
Remember that outrageous real estate deal I was offered back in July?
A big bank was raising $500 million to buy a building in midtown Manhattan… then they wanted to spend another $1,000 per square foot on renovations.
I immediately passed. Why would I buy a building in one of the most expensive cities in the world, at a market high… then spend a fortune (and several years) renovating the property… then pray we don’t have a market downturn so I can sell the property to a higher bidder.
Well, now we know who likely took the $500 million allocation – pension funds.
Calstrs, one of the largest pension funds in the US, has allocated $5.7 billion to opportunistic real estate. And they think they’re going to make 13% to 30% on these investments (compared to 6% to 9% with traditional real estate).
What could possibly go wrong here?
Ten years into a raging bull market, pension funds aren’t just buying expensive real estate… They are buying expensive real estate and taking on debt to develop it. And they are hoping that years from now when the property is finished, the market will still be in a position to buy what they have built at a higher price.
Everything needs to go right for pensions to make money on these investments. But I see a lot more that can go wrong.
I was able to pass on this deal. But the millions of Americans depending on a pension for retirement don’t have that luxury… they’re at the mercy of the pension managers to make decisions for them.
And they are not making sound decisions today.
Are We In A Recession Already?
ZeroHedge.com Fri, 12/07/2018 - 17:45
Authored by Charles Hugh Smith via OfTwoMinds blog,
The value of declaring the entire nation in or out of recession is limited.
Recessions are typically only visible to statisticians long after the fact, but they are often visible in real time on the ground: business volume drops, people stop buying houses and vehicles, restaurants that were jammed are suddenly sepulchral and so on.
There are well-known canaries in the coal mine in terms of indicators. These include building permits, architectural bookings, air travel, and auto and home sales. Home sales are already dropping in most areas, and vehicle sales are softening. Airlines and tourism may continue on for awhile as people have already booked their travel, but the slowdown in other spending can be remarkably abrupt.
All nations are mosaics of local economies, and large nations like the U.S. are mosaics of local and regional economies, some of which (California, Texas, New York) are the equivalent of entire nations in and of themselves.As a result, there can be areas where the Great Recession of 2008-09 never really ended, and other areas that have experienced unprecedented building booms (for example, the San Francisco Bay Area where I live part-time.)
Changes in sentiment are reflected in different sectors of the economy: people become hesitant about big purchases first (autos, houses) and then start deciding to save more by spending less (Christmas shopping, eating out, vacations, etc.)
Given the structural asymmetries of our economy (a few winners, most people lucky to be losing ground slowly), each economic class also responds differently. The lower 60% of households don't have the disposable income of the top 10%, so "cutting back" for them might be buying fewer fast-food meals per week.
The top 10% have the majority of the nation's disposable income, just as they own two-thirds of the wealth. If the sources of their income tanks (tech bubble pops, etc.), then signs of recession in this class will be a decline in high-cost consumption: luxury store sales, fancy restaurants, etc.
In other words, different classes, sectors and regions of the economy can be recession while others are still doing fine.
As a result, the value of declaring the entire nation in or out of recession is limited. While national conditions such as mortgage rates and Treasury yields are consequential, the recessionary effects will likely be as asymmetric as the economy: the effects will vary considerably depending on how each sector, class and region are doing.
To summarize: the top 10% may never experience a recession that guts the bottom 90%, who depend on wages rather than earnings from capital.
Historic Debt Is At The Core Of Our Decline
ZeroHedge.com Fri, 12/07/2018 - 19:45
Authored by Brandon Smith via Alt-Market.com,
This article was originally published at Birch Gold Group
As I predicted just after the 2016 presidential election, a sordid theater of blame has exploded over the state of the U.S. economy, with fingers pointing everywhere except (in most cases) at the true culprits behind the crash. Some people point to the current administration and its pursuit of a trade war. Others point to the Federal Reserve, with its adverse interest rate hikes into economic weakness and its balance sheet cuts.
Some blame the Democrats for doubling the national debt under the Obama Administration and creating massive trade and budget deficits. And others look towards Republicans for not yet stemming the continually increasing national debt and deficits.
In today’s economic landscape, the debt issue is absolutely critical. While it is often brought up in regards to our fiscal uncertainty, it is rarely explored deeply enough.
I believe that economic crisis events are engineered deliberately by the financial elite in order to create advantageous conditions for themselves. To understand why, it is important to know the root of their power.
Without extreme debt conditions, economic downturns cannot be created (or at least sustained for long periods of time). According to the amount of debt weighing down a system, banking institutions can predict the outcomes of certain actions and also influence certain end results. For example, if the Fed was interested in conjuring a debt based bubble, a classic strategy would be to set interest rates artificially low for far too long. Conversely, raising interest rates into economic weakness is a strategy that can be employed in order to collapse a bubble. This is what launched the Great Depression, it is what ignited the crash of 2008, and it is what’s going on today. The massive debt burden makes recovery difficult, if not impossible, and thus the system becomes increasingly dependent on the banking elites to resolve the problem.
Debt is the fuel that keeps the centralization machine running. I am not talking about standard lending, though this can be a factor. What I'm talking about is debt created through policy; debt that’s created in an instant through the use of subversive and arbitrary measures, like central bank balance sheet initiatives or interest rates. And, debt that’s created through collusion between central banks, international banks, ratings agencies, and government using the removal of regulations, or the implementation of unfair regulatory standards.
Debt is a drug. The banks have known this for quite some time and have exploited the opiate of easy money to leverage entire nations and cultures into servitude or self-destruction. To illustrate this point, let’s look at the debt numbers today.
The national debt is closing in on $22 trillion, with over $1 trillion a year currently being added for the American taxpayer.
Corporate debt is at historic highs not seen since 2008, with S&P Global reporting over $6.3 trillion in total debts and the largest companies holding only $2.1 trillion in cash as a hedge.
U.S. household debt currently stands at around $13.3 trillion, which is $618 billion higher than the last peak back in 2008, during the credit crisis. U.S. credit card debt surpassed $1 trillion for the first time in 2018, the highest single year amount since 2007 (once again, we see that debt levels are spiking beyond the lines crossed just before the crash of 2008).
So how can this debt be exploited to engineer an economic crisis?
Let’s start with household and consumer debt.
One would think that with so much lending and creation of consumer debt, we would see a massive expansion in home and auto markets. And for a time, we did. The problem was that most home purchases were being undertaken by major corporations like Blackrock, as they devoured distressed mortgages by the thousands and then turned those homes into rentals. In the auto market, there was a large spike in buying driven by lending, but this lending was accomplished through ARM-style car loans, the same kind of loans with lax standards that helped cause the mortgage crisis in 2008
Today, both in the housing market and the auto market, a crash is indeed taking place as the Fed raises interest rates and makes holding these loans ever more expensive. Pending home sales have tumbled to a four-year low, as one in four homes on the market is now forced to lower prices. Debt is becoming expensive, and therefore demand is slumping.
Overall U.S. auto sales began a precipitous decline this September, which has continued through November, mostly due to higher interest rates. It is clear that an economic crash, which some are merely calling a bear market, is indicated in the swift decline in housing and autos, two of the most vital consumer sectors.
But what about corporate debt? Let’s use GE, GM and Ford as litmus tests.
GE is currently in the red for over $115 billion. And this doesn’t include its pension promises to employees, which amount to over $100 billion. Given that only $71 billion has been earmarked to cover the payments, any rate hikes from the Fed constitute a millstone on the necks of GE. The likely result will be continued layoffs. Last December, GE announced 12,000 jobs to be cut through 2018, and it is likely cuts will continue into 2019.
GM, with long term debt of $102 billion (as of September) and cash holdings of around $35 billion, is now cutting over 14,000 jobs and shutting down multiple factories in the U.S. This is due, in part, to a combination of interest rate hikes and tariffs. However, the true point of fracture is because of the expansive debt that GM is responsible for. Without such debt, neither rate hikes nor Trump’s tariffs would have as intense an effect on these corporations.
Ford, not to be outdone by GM, is set to announce up to 25,000 job cuts, though the bulk of them may be implemented in Europe. Ford has called this report by Morgan Stanley "premature", but we saw many similar "non-denial-denials" of these kinds of info leaks during the crash of 2008, and most of them ended up being true. Ford saw its debt rating downgraded by Moody’s earlier this year to one step above junk. With current liabilities of around $100 billion and only $25 billion in cash holdings, Ford is yet another company of the verge of crumbling due to huge liabilities it cannot afford to pay more interest on.
We can see the stress that the Fed is able to place on corporations by looking at their stock buyback expenditures over the past few years. Until recently, it was the Fed’s low interest rates, overnight loans, and balance sheet purchases that allowed companies to buy back their own stocks and thereby artificially prop up the markets. In fact, one could argue that without stock buybacks, the bull rally that started in 2009 would have died out a long time ago and we would have returned to crash conditions much sooner.
Well, this is exactly what is happening today. Stock buybacks in the last half of 2018 are dwindling as the Fed tightens policy and interest rates draw ever closer to the designated "neutral rate" of inflation. All it took as a measly 2% increase in interest to create a crisis, but with the level of debt choking the system, this should not be surprising to anyone.
By lowering interest rates to near zero, what the Fed did was create a culture of irresponsible risk, and I believe they did this knowingly. Even Donald Trump has tied himself to the performance of the stock market and embraced the debt addiction, arguing for the Fed to stop or reduce interest rate hikes to keep the debt party going. Though, with Trump's White House crawling with international banking agents and think-tank ghouls there might be far more than meets the eye as Trump anchors himself to the performance of the Dow.
The Fed is not going to stop. Why would they? They have created the perfect bubble. A bubble that encompasses not only corporate debt, consumer debt, and stock markets, but also bond markets and the U.S. dollar itself. If the goal is a move to centralize power, then the banking elites have the perfect crisis weapon in their hands, and they barely need to lift a finger (or raise rates) to trigger the event.
As noted earlier, it is not only stock investors that are dependent on Fed interest rates, but also the U.S. government, as treasury debt becomes less desirable for foreign buyers. The higher the potential interest barrier for the US, the higher the cost, and the less faith foreign buyers have in our ability cover our liabilities while the Fed is still tightening.
Both China and Japan have been quietly reducing treasury holdings and purchases. Failing bond auctions have been cited as a trigger for spikes in Treasury yields since the beginning of 2018. Again, even U.S. debt and the dollar are embroiled in the “everything bubble”.
Debt in itself is not necessarily just a tool to gain more wealth; it is also a tool to change and mold societies through financial leverage and disaster. To understand who is creating any fiscal downturn, and to understand who benefits from economic crisis, one only needs to consider who controls the debt.
3 Things That Happened Just Before The 2008 Crisis Are Happening Again Right Now
ZeroHedge.com Fri, 11/30/2018 - 11:10
Authored by Michael Snyder via The Economic Collapse blog,
Real estate, oil and the employment numbers are all telling us the same thing, and that is really bad news for the U.S. economy. It really does appear that economic activity is starting to slow down significantly, but just like in 2008 those that are running things don’t want to admit the reality of what we are facing. Back then, Fed Chair Ben Bernanke insisted that the U.S. economy was not heading into a recession, and we later learned that a recession had already begun when he made that statement. And as you will see at the end of this article, current Fed Chair Jerome Powell says that he is “very happy” with how the U.S. economy is performing, but he shouldn’t be so thrilled.
Signs of trouble are everywhere, and we just got several more pieces of troubling news.
Thanks to aggressive rate hikes by the Federal Reserve, the average rate on a 30 year mortgage is now up to about 4.8 percent. Just like in 2008, that is killing the housing market and it has us on the precipice of another real estate meltdown.
And some of the markets that were once the hottest in the entire country are leading the way down. For example, just check out what is happening in Manhattan…
In the third quarter, the median price for a one-bedroom Manhattan home was $815,000, down 4% from the same period in 2017. The volume of sales fell 12.7%.
Of course things are even worse at the high end of the market. Some Manhattan townhouses are selling for millions of dollars less than what they were originally listed for.
Sadly, Manhattan is far from alone. Pending home sales are down all over the nation. In October, U.S. pending home sales were down 4.6 percent on a year over year basis, and that was the tenth month in a row that we have seen a decline…
Hope was high for a rebound (after new-home-sales slumped), but that was dashed as pending home sales plunged 2.6% MoM in October (well below the expected 0.5% MoM bounce).
Additionally, Pending Home Sales fell 4.6% YoY – the 10th consecutive month of annual declines…
When something happens for 10 months in a row, I think that you can safely say that a trend has started.
Sales of new homes continue to plummet as well. In fact, we just witnessed a 12 percent year over year decline for sales of new single family houses last month…
Sales of new single-family houses plunged 12% in October, compared to a year ago, to a seasonally adjusted annual rate of 544,000 houses, according to estimates by the Census Bureau and the Department of Housing and Urban Development.
With an inventory of new houses for sale at 336,000 (seasonally adjusted), the supply at the current rate of sales spiked to 7.4 months, from 6.5 months’ supply in September, and from 5.6 months’ supply a year ago.
If all of this sounds eerily similar to 2008, that is because it is eerily similar to what happened just before and during the last financial crisis.
Up until now, at least the economic optimists could point to the employment numbers as a reason for hope, but not anymore.
In fact, initial claims for unemployment benefits have now risen for three weeks in a row…
The number of Americans filing applications for jobless benefits increased to a six-month high last week, which could raise concerns that the labor market could be slowing.
Initial claims for state unemployment benefits rose 10,000 to a seasonally adjusted 234,000 for the week ended Nov. 24, the highest level since the mid-May, the Labor Department said on Thursday. Claims have now risen for three straight weeks.
This is also similar to what we witnessed back in 2008. Jobless claims started to creep up, and then when the crisis fully erupted there was an avalanche of job losses.
And just like 10 years ago, we are starting to see a lot of big corporations start to announce major layoffs.
General Motors greatly upset President Trump when they announced that they were cutting 14,000 jobs just before the holidays, but GM is far from alone. For a list of some of the large firms that have just announced layoffs, please see my previous article entitled “U.S. Job Losses Accelerate: Here Are 10 Big Companies That Are Cutting Jobs Or Laying Off Workers”.
A third parallel to 2008 is what is happening to the price of oil.
In 2008, the price of oil shot up to a record high before falling precipitously.
Well, now a similar thing has happened. Earlier this year the price of oil shot up to $76 a barrel, but this week it slid beneath the all-important $50 barrier…
Oil’s recent slide has shaved more than a third off its price. Crude fell more than 1% Thursday to as low as $49.41 a barrel. The last time oil closed below $50 was in October 4, 2017. By mid morning the price had climbed back to above $51.
Concerns about oversupply have sent oil prices into a virtual free-fall: Crude hit a four-year high above $76 a barrel less than two months ago.
When economists are asked why the price of oil is falling, the primary answer they give is because global economic activity is softening.
And that is definitely the case. In fact, we just learned that economic confidence in the eurozone has declined for the 11th month in a row…
Euro-area economic confidence slipped for an 11th straight month, further damping expectations that the currency bloc will rebound from a sharp growth slowdown and complicating the European Central Bank’s plans to pare back stimulus.
In addition, we just got news that the Swiss and Swedish economies had negative growth in the third quarter. The economic news is bad across the board, and it appears to be undeniable that a global economic downturn has begun. But current Fed Chair Jerome Powell insists that he is “very happy about the state of the economy”…
Jerome H. Powell, the Federal Reserve’s chairman, has also taken an optimistic line, declaring in Texas recently that he was “very happy about the state of the economy.” That is just great. He can be as happy as he wants, and he can continue raising interest rates as he sticks his head in the sand, but nothing is going to change economic reality.
Every single Fed rate hiking cycle in history has ended in a market crash and/or a recession, and this time won’t be any different.
The Federal Reserve created the “boom” that we witnessed in recent years, but we must also hold them responsible for the “bust” that is about to happen.
This Is How The "Everything Bubble" Will End
ZeroHedge.com Fri, 11/30/2018 - 17:45
Authored by Nick Giambruno via InternationalMan.com,
I think there’s a very high chance of a stock market crash of historic proportions before the end of Trump’s first term.
That’s because the Federal Reserve’s current rate-hiking cycle, which started in 2015, is set to pop “the everything bubble.”
I’ll explain how this could all play out in a moment. But first, you need to know how the Fed creates the boom-bust cycle…
To start, the Fed encourages malinvestment by suppressing interest rates lower than their natural levels. This leads companies to invest in plants, equipment, and other capital assets that only appear profitable because borrowing money is cheap.
This, in turn, leads to misallocated capital – and eventually, economic loss when interest rates rise, making previously economic investments uneconomic.
Think of this dynamic like a variable rate mortgage. Artificially low interest rates encourage individual home buyers to take out mortgages. If interest rates stay low, they can make the payments and maintain the illusion of solvency. But once interest rates rise, the mortgage interest payments adjust higher, making them less and less affordable until, eventually, the borrower defaults.
In short, bubbles are inflated when easy money from low interest rates floods into a certain asset.
Rate hikes do the opposite. They suck money out of the economy and pop the bubbles created from low rates.
It Almost Always Ends in a Crisis
Almost every Fed rate-hiking cycle ends in a crisis. Sometimes it starts abroad, but it always filters back to U.S. markets.
Specifically, 16 of the last 19 times the Fed started a series of interest rate hikes, some sort of crisis that tanked the stock market followed. That’s around 84% of the time.
You can see some of the more prominent examples in the chart below.
Let’s walk through a few of the major crises…
• 1929 Wall Street Crash
Throughout the 1920s, the Federal Reserve’s easy money policies helped create an enormous stock market bubble.
In August 1929, the Fed raised interest rates and effectively ended the easy credit.
Only a few months later, the bubble burst on Black Tuesday. The Dow lost over 12% that day. It was the most devastating stock market crash in the U.S. up to that point. It also signaled the beginning of the Great Depression.Between 1929 and 1932, the stock market went on to lose 86% of its value.
• 1987 Stock Market Crash
In February 1987, the Fed decided to tighten by withdrawing liquidity from the market. This pushed interest rates up. They continued to tighten until the “Black Monday” crash in October of that year, when the S&P 500 lost 33% of its value.
At that point, the Fed quickly reversed its course and started easing again. It was the Chairman of the Federal Reserve Alan Greenspan’s first – but not last – bungled attempt to raise interest rates.
• Asia Crisis and LTCM Collapse
A similar pattern played out in the mid-1990s. Emerging markets – which had borrowed from foreigners during a period of relatively low interest rates – found themselves in big trouble once Greenspan’s Fed started to raise rates. This time, the crisis started in Asia, spread to Russia, and then finally hit the U.S., where markets fell over 20%.
Long-Term Capital Management (LTCM) was a large U.S. hedge fund. It had borrowed heavily to invest in Russia and the affected Asian countries. It soon found itself insolvent. For the Fed, however, its size meant the fund was “too big to fail.” Eventually, LTCM was bailed out.
• Tech Bubble
Greenspan’s next rate-hike cycle helped to puncture the tech bubble (which he’d helped inflate with easy money). After the tech bubble burst, the S&P 500 was cut in half.
• Subprime Meltdown and the 2008 Financial Crisis
The end of the tech bubble caused an economic downturn. Alan Greenspan’s Fed responded by dramatically lowering interest rates. This new, easy money ended up flowing into the housing market. Then in 2004, the Fed embarked on another rate-hiking cycle. The higher interest rates made it impossible for many Americans to service their mortgage debts. Mortgage debts were widely securitized and sold to large financial institutions. When the underlying mortgages started to go south, so did these mortgage-backed securities, and so did the financial institutions that held them. It created a cascading crisis that nearly collapsed the global financial system. The S&P 500 fell by over 56%.
• 2018: The “Everything Bubble”
I think another crisis is imminent…
As you probably know, the Fed responded to the 2008 financial crisis with unprecedented amounts of easy money.
Think of the trillions of dollars in money printing programs – euphemistically called quantitative easing (QE) 1, 2, and 3. At the same time, the Fed effectively took interest rates to zero, the lowest they’ve been in the entire history of the U.S.
Allegedly, the Fed did this all to save the economy. In reality, it has created enormous and unprecedented economic distortions and misallocations of capital. And it’s all going to be flushed out. In other words, the Fed’s response to the last crisis sowed the seeds for an even bigger crisis. The trillions of dollars the Fed “printed” created not just a housing bubble or a tech bubble, but an “everything bubble.” The Fed took interest rates to zero in 2008. It held them there until December 2015 – nearly seven years. For perspective, the Fed inflated the housing bubble with about two years of 1% interest rates. So it’s hard to fathom how much it distorted the economy with seven years of 0% interest rates.
The Fed Will Pop This Bubble, Too
Since December 2015, the Fed has been steadily raising rates, roughly 0.25% per quarter.
I think this rate-hike cycle is going to pop the “everything bubble.” And I see multiple warning signs that this pop is imminent.
• Warning Sign No. 1 – Emerging Markets Are Flashing Red
Earlier this year, the Turkish lira lost over 40% of its value. The Argentine peso tanked a similar amount.
These currency crises could foreshadow a coming crisis in the U.S., much in the same way the Asian financial crisis/Russian debt default did in the late 1990s.
• Warning Sign No. 2 – Unsustainable Economic Expansion
Trillions of dollars in easy money have fueled the second-longest economic expansion in U.S. history, as measured by GDP. If it’s sustained until July 2019, it will become the longest in U.S. history.In other words, by historical standards, the current economic expansion will likely end before the next presidential election.
• Warning Sign No. 3 – The Longest Bull Market Yet
Earlier this year, the U.S. stock market broke the all-time record for the longest bull market in history. The market has been rising for nearly a decade straight without a 20% correction.
Meanwhile, stock market valuations are nearing their highest levels in all of history.
The S&P 500’s CAPE ratio, for example, is now the second-highest it’s ever been. (A high CAPE ratio means stocks are expensive.) The only time it was higher was right before the tech bubble burst.
Every time stock valuations have approached these nosebleed levels, a major crash has followed.
Preparing for the Pop
The U.S. economy and stock market are overdue for a recession and correction by any historical standard, regardless of what the Fed does. But when you add in the Fed’s current rate-hiking cycle – the same catalyst for previous bubble pops – the likelihood of a stock market crash of historic proportions, before the end of Trump’s first term, is very high.That’s why investors should prepare now. One way to do that is by shorting the market. That means betting the market will fall.
Keep in mind, I’m not in the habit of making “doomsday” predictions. Simply put, the Fed has warped the economy far more drastically than it did in the 1920s, during the tech or housing bubbles, or during any other period in history.
I expect the resulting stock market crash to be that much bigger.
For the U.S. Economy, Storm Clouds on the Horizon
By Binyamin Appelbaum, New York Times Nov. 28, 2018
WASHINGTON — Emerging signs of weakness in major economic sectors, including auto manufacturing, agriculture and home building, are prompting some forecasters to warn that one of the longest periods of economic growth in U.S. history may be approaching the end of its run.
The economy has been a picture of health, expanding at a 3.5 percent annual pace during the third quarter and driving the unemployment rate to 3.7 percent, the lowest level in almost half a century. But General Motors’ plans to cut 14,000 jobs and shutter five factories reinforces other recent indications that the better part of the expansion is now in the rearview mirror.
“We’re in the 10th year of the expansion, and there are some soft points,” said Ellen Hughes-Cromwick, a former chief economist at Ford Motor Co. and the Commerce Department who is now on the faculty at the University of Michigan. “The auto sales cycle has peaked, and the housing cycle also has peaked.” If interest rates continue to rise, she said, “I don’t really see how the economy can keep powering ahead.”
The vast majority of prominent economic forecasters, including various arms of the federal government and all of the major Wall Street banks, still regard continued growth as the most likely outcome for the U.S. economy in 2019. But there is a broad consensus that the pace of growth will slow as the sugar high provided by the Trump administration’s $1.5 trillion tax cut and spending increases begins to wear off. And some forecasters see a small, but growing, chance of a recession.
President Donald Trump’s chief economic adviser, Larry Kudlow, tried to play down such concerns Tuesday, insisting that the overall health of the economy remained robust. “There’s a certain amount of pessimism I’m reading about, maybe it has to do with a mild stock market correction,” Kudlow said, before describing such pessimism as misplaced. He rattled off recent economic data — including the most recent jobs report, which he described as “very spiffy” — to highlight the strength of the U.S. economy, before his conclusion: “We’re in very good shape.”
Jerome H. Powell, the Federal Reserve’s chairman, has also taken an optimistic line, declaring in Texas recently that he was “very happy about the state of the economy.”
The basic cause for concern is a widening gap between the evident strength of the economy this year and weakness in economic indicators that look ahead to coming years. That gap was highlighted Tuesday in the latest data on consumer confidence, which showed Americans remained pleased with their present circumstances, but were less confident that growth would continue.
Investors are showing signs of concern about the ability of the corporate sector to maintain sky-high levels of profitability. Major stock indexes are roughly flat for the year. Some businesses are starting to worry, too. Farmers are facing large losses because they cannot sell crops to China during a trade war between Washington and Beijing. Sales of new and existing homes have declined in recent months as interest rates rise. Auto sales, also vulnerable to higher rates, have been falling since 2016.
“This is a geriatric expansion,” said David Kelly, chief global strategist at JPMorgan Funds.
Kelly noted that if economic growth continued through next summer, this would become the longest-running expansion of the U.S. economy since at least the Civil War.
It is proverbial among economists that expansions do not die of old age. But the end of Trump’s fiscal stimulus will most likely drop economic growth back toward an annual rate around 2 percent, leaving little margin for error. “It wouldn’t take much to go wrong to put us into a recession,” Kelly said.
Many analysts regard Trump and Powell as the greatest threats to the economic expansion.
Trump’s trade war with China has yet to make a discernible dent in domestic growth, but if the conflict continues, or escalates, the impact on the economy could increase.
Another concern is that the Fed’s current path of interest rate increases will choke growth.
Both forces already are battering the automobile industry. Trump’s tariffs on aluminum and steel have raised costs for carmakers, the nation’s largest consumer of those materials. The Fed’s rate increases, meanwhile, have raised the cost of car loans, discouraging potential buyers.
Trump told The Washington Post on Tuesday that the Fed was undermining economic growth and blamed it for the woes of General Motors. “I’m doing deals, and I’m not being accommodated by the Fed,” he said. “They’re making a mistake because I have a gut, and my gut tells me more sometimes than anybody else’s brain can ever tell me.” The Fed is widely expected to raise its benchmark interest rate for a fourth time this year at its next meeting, in mid-December. But Fed officials, well aware of the danger, have emphasized in recent weeks that their plans for next year will depend on the evolution of the economic data.
Richard Clarida, the Fed’s vice chairman, said Tuesday the economy remained “robust,” and the Fed planned to keep raising rates. Deciding how high to go, he said, would require “judgment and humility.”
Powell said this month that the Fed would proceed like a man in a dark room. “What do you do?” he said. “You slow down. You stop, probably, and feel your way. It’s not different with policy.”
GM’s cuts reflect the particular challenges facing the auto industry, including the nascent shift toward electric and self-driving vehicles. Mary T. Barra, the company’s chief executive, said GM was eliminating some mechanical engineers to make room for more software engineers. And she said the company was not acting in anticipation of a recession. “We are taking these actions now while the company and the economy are strong to stay in front of a fast-changing market,” she said.
But the company’s retrenchment underscored the broader fragility of the economic expansion. GM must fund its investment plans by cutting back in other parts of its business because its costs are rising while its sales are declining in both of its major markets: the United States and China.
The Trump administration said its economic policies would deliver a lasting boost to growth, and Trump specifically highlighted the auto industry, and GM, as beneficiaries of those policies. So far, however, those policies have delivered a short-term increase in spending. The tax cuts passed in 2017 were designed to encourage investment: New factories, new equipment, new products. Tariffs on foreign steel and aluminum, and on Chinese goods, were supposed to serve the same purpose. But GM has said the cost of the tariffs exceeds the benefits from the tax cuts — and instead of building new factories, GM is moving to shutter domestic plants.
Kudlow defended the administration’s policies Tuesday and said that revisions to the North American Free Trade Agreement would help the auto industry. “There’s a lot of disappointment, even anger,” about the company’s decision, he said. The administration also said it was considering ways of punishing GM by ending other federal subsidies, which seemed unlikely to help the economy.
Some analysts say the focus on what might go wrong is obscuring the reality that the economy remains strong. The primary engine of growth is consumer spending, which accounts for about two-thirds of economic activity. The pace of wage gains has increased, consumer confidence remains close to the post-recession high set earlier this year, and retailers are anticipating a strong holiday season.
“Consumers haven’t run out of money and confidence yet, which means economic growth remains on track,” said Chris Rupkey, chief financial economist at MUFG. Rupkey noted that 46.6 percent of consumers said in the November survey of consumer confidence that good jobs were plentiful, the best figure during the current recovery. “Why is confidence so high?” he asked. “It’s jobs, jobs, jobs.”