Posted June 15, 2022
By Jim Rickards
“These People Never Learn”
Here’s the good news: The stock market didn’t lose nearly as much today as it did yesterday. The Nasdaq even posted a 19-point gain.
Of course the Dow still lost another 151 points and the S&P lost another 14. The S&P slipped into bear market territory yesterday, which doesn’t bode well for the economy.
Since 1970, whenever the stock market fell 18% or more over a four-month time frame, the economy fell into recession every time. Well, that’s exactly what we’ve seen.
But after yesterday’s bloodbath, I heard a well-regarded business TV anchor ask her guest about "green shoots."
I nearly fell out of my chair, laughing. These people never learn.
“Green shoots” was the ubiquitous phrase used by White House officials and TV talking heads in 2009 to describe how the U.S. economy was coming back to life after the 2008 global financial crisis.
The problem was we did not get green shoots, we got brown weeds.
False Hopes, False Dawns
The economy did recover but it was the slowest recovery in U.S. history. After the green shoots theory had been discredited, Treasury Secretary Tim Geithner promised a "recovery summer" in 2010.
That didn't happen either.
The recovery did continue, but it took years for the stock market to return to the 2017 highs and even longer for unemployment to come down to levels that could be regarded as close to full employment.
In the aftermath of the 2020 pandemic and resultant market crash, the same voices were at it again.
The White House talked about "pent-up demand" as the economy reopened and consumers flocked to stores and restaurants to make up for the lost spending during the lockdowns.
But that "pent-up demand" theory was just as much of a mirage as the green shoots were. Now with surging inflation and broken supply chains, we’re on the verge of recession, if not already in one.
Monetary policy won't get us out because the Fed is basically out of “dry powder,” despite its recent rate hikes (and the one we’ll see tomorrow). There’s just not enough room to cut rates before being back to zero.
The rate increases will only damage an already slowing economy and drag the stock market further down.
Money Velocity Has Fallen for 20 Years
Meanwhile, the velocity of money, the rate at which money changes hands, has been crashing for the past 20 years. From its peak of 2.2 in 1997 (each dollar supported $2.20 of nominal GDP), it fell to 2.0 in 2006 just before the global financial crisis and then crashed to 1.7 in mid-2009 as the crisis hit bottom.
The velocity crash did not stop with the market crash. It continued to fall to 1.43 by late 2017, despite the Fed's money printing and zero rate policy (2008–15). Even before the pandemic, it fell to 1.37 in early 2020.
It can be expected to fall even further as the new depression drags on. As velocity falls, the economy falls. Money printing is impotent: $7 trillion times zero = zero. There is no economy without velocity.
And oh, by the way, money velocity has essentially ground to a halt over the past two months.
The bottom line is monetary policy can do very little to stimulate the economy unless the velocity of money increases. And the prospects of that happening aren't great right now.
But what about fiscal policy? Can that help get the economy out of depression? Let's take a look…
Saturated With Debt
We saw more deficit spending in the past couple of years than in the past several years combined. The government has added more to the national debt these past few years than all presidents combined from George Washington to Bill Clinton.
The added debt has increased the U.S. debt-to-GDP ratio to about 125%. That's the highest in U.S. history and puts the U.S. in the same super-debtors league as Japan, Greece, Italy and Lebanon.
The idea that deficit spending can stimulate an otherwise stalled economy dates to John Maynard Keynes and his classic work The General Theory of Employment, Interest and Money (1936).
Keynes' idea is straightforward.
He says that each dollar of government spending produces more than $1 of growth. When the government spends money (or gives it away), the recipient spends it on goods or services. Those providers of goods and services, in turn, pay their wholesalers and suppliers.
This increases the velocity of money.
Depending on the exact economic conditions, it might be possible to generate $1.30 of nominal GDP for each $1.00 of deficit spending. This was the famous Keynesian multiplier. To some extent, the deficit would pay for itself in increased output and increased tax revenues.
Here's the problem: There is strong evidence that the Keynesian multiplier does not exist when debt levels are already too high.
More Dollars, Less Growth
In fact, America and the world are inching closer to what economists Carmen Reinhart and Ken Rogoff describe as an indeterminate yet real point where an ever-increasing debt burden triggers creditor revulsion, forcing a debtor nation into austerity, outright default or sky-high interest rates.
Reinhart and Rogoff's research reveals that a 90% debt-to-GDP ratio or higher is not just more of the same debt stimulus. Rather it's what physicists call a critical threshold.
The first effect is the Keynesian multiplier falls below one. That means one dollar of debt and spending produces less than a dollar of growth. Creditors grow anxious while continuing to buy more debt in a vain hope that policymakers reverse course or growth spontaneously emerges to lower the ratio.
This doesn't happen. Society is addicted to debt, and the addiction consumes the addict.
The national debt is $30.5 trillion. A $30.5 trillion debt would not be a serious issue if we had a $50 trillion economy.
But we don't have a $50 trillion economy. We have about a $21 trillion economy, which means our debt is substantially bigger than our economy. And the economy is stalling.
The endpoint is a rapid collapse of confidence in U.S. debt and the U.S. dollar. This means higher interest rates to attract investor dollars to continue financing the deficits.
Of course, higher interest rates mean larger deficits, which makes the debt situation worse. Or the Fed could monetize the debt, yet that's just another path to lost confidence.
The result is another 20 years of slow growth, austerity, financial repression (where interest rates are held below the rate of inflation to gradually extinguish the real value of debt) and an expanding wealth gap.
The next two decades of U.S. growth would look like the last two decades in Japan. Not a collapse, just a slow, prolonged stagnation. This is the economic reality we are facing.
And neither monetary policy nor fiscal policy will change that. Don’t expect to see too many “green shoots” anytime soon.