Advancing Time: The Devastating Impact Of Reverse Wealth Effect

Advancing Time: The Devastating Impact Of Reverse Wealth Effect: Most people find the pain of losing wealth exceeds the joy they get from gaining. While consumers feel more financially secure and confident...

The Devastating Impact Of Reverse Wealth Effect

Most people find the pain of losing wealth exceeds the joy they get from gaining. While consumers feel more financially secure and confident they spend more freely, the reverse is also true. Get ready for the "reverse wealth effect" to kick in. If this happens it will be a real ball breaker. The wealth effect is a behavioral economic theory based on people spending more as the value of their assets rise. Even decades after its economic bubble popped, Japan stands as a monument to the devastation the reverse wealth effect can unleash.

The complacency that has developed from years of markets moving ever higher has insulated huge numbers of investors from the reality bad times may be in the cards. In addition to complacency the market is being supported by the idea the moment any bad thing happens the Fed will pivot. In such a situation the expectation is the Fed put will kick in. This translates into it might be better to tough out a drop because it may not be possible to get back in when the market V bottoms out of the drop. 

Higher for longer is a force that has yet to play out. The bond markets scream caution. The mixed signals flowing from the debt market have left open the possibility the bond markets could become a wrecking ball. This would result in the FED being forced to intervene and the potential for a debt death spiral. We must not forget that for over a decade, super low or negative interest rates forced people to invest in stock markets in search of yield. As this money is pulled out of stocks and returns to safer alternatives stocks may decline striping people of their paper gains.

Circling back to the crux of this post, much of the rationale behind QE has been that it creates what the Fed calls a “Wealth Effect.” For years this has been a key driver of central bank policy. This view is firmly embedded in the macro-econometric models used by the Fed. The notion, widely adopted by central bankers, is that by inflating asset prices to make the wealthy (the asset holders) even wealthier, these people will spend more of what they see as free money from asset price inflation. The premise is that this additional spending will create additional demand for goods and services thus providing jobs for the masses. 

Sadly, several times over the years the wealth effect formula has slid off the tracks and most likely will again. Consumption does not create wealth, it creates debt. The example that stands out in the minds of most people is from back in 2008. By loaning money against homes with little scrutiny as to the borrower's ability to repay them the Fed created a financial bubble with broad implications. It could be argued that since 2008, Fed policy has never really addressed that mess but attempted to paper over it by printing money and expanding debt through quantitative easing.

In a world where optimism and hope have dominated the investment landscape for over a decade, we should be prepared for reality to raise its ugly head. This time is not different and debt does matter. As pointed out by many economists over the years, low-interest rates and easy money, do not always result in a strong vibrant economy. Japan's failure to recover from its bubble bursting decades ago remains proof of this.

The problem is that the policy track we have been on may of driven consumer buying, but it also created a lot of debt and waste. This has been great for certain sectors of the economy such as the financial sector but it has failed to generate the kind of growth that makes an economy strong.

Wealth Effect Policies Have Failed To Generate Enough "Real Growth"

Looking back throughout history we see the policies that breed the Wealth Effect can slide off track or lose their effectiveness while creating risk. At some point, the combination of easy-to-borrow money at low-interest rates tends to morph into a high-risk environment of increased speculation and leverage. In short, savers and investors seeking a return on their savings are forced out of traditional accounts because such investments get ravaged by inflation.

Many Consumers Bought Into This

We must not forget the 2008 financial crisis resulted in the worst economic disaster since the great depression of 1930. It is also referred to as the global financial crisis (GFC). It should be noted the Fed's response to the GFC has gotten a great deal of well-deserved bad press for driving inequality and fracturing society. Since 2008 it has become apparent the Fed has created an unfair system that is broken, unfair, and corrupt. This has affected different generations in rather specific ways.

The amount of debt generated since 2008 screams that wealth effect policies are not working. Not only have they failed to create a healthy economy but they feeding into a self-feeding loop of more debt. Following the GFC the Federal Reserve and the Bush administration spent hundreds of billions of dollars to add liquidity to the financial markets. They worked hard to avoid a complete collapse. They almost didn't succeed. Today we are spending not billions, but trillions of dollars to keep the same corrupt policy moving forward. 

Investors should treat the wealth effect with caution because it is susceptible to harsh reversals. Since the GFC, attempt after attempt has been put forth to change the tide, but still, we have watched the middle class shrink. The elephant in the room when it comes to growing the economy is how "the broken window theory" is spun and interpreted. The gist of this theory is that if a window is broken, the subsequent repair expenditure will have no net benefits for the economy. Still, it is not uncommon to see destruction touted as a good thing because it promotes spending. 

In truth, the broken window idea of destruction is good discounts several facts. One has to do with where the money is coming from but whether it is from an insurance company or someplace else, it still means the money is diverted from being used on another purchase. Repairing a broken window is maintenance spending which doesn’t improve growth because it doesn’t improve productivity. This expenditure would have occurred anyway. The only thing a broken window does is  cause maintenance spending to occur earlier and lower the useful life of the window. Maintenance spending may keep the economy going it doesn’t provide a boost. Instead, it is better to invest the money in something which creates wealth by increasing productivity.

Many people and even economists have real misconceptions as to how the economy works. Where money flows and who it enriches is a key component of economics. This is a blind spot many people have. Years of being told everything revolves around spending has diminished the important role savings plays in the scheme of a balanced economy. Fans of Keynesian economics that encourage government spending to stabilize the economy during a downturn tend to discount the importance that where and how money is spent matters a great deal. 

Wealth Effect Policy Has Flaws

In the end, this all comes back to the fact current policies are presenting us with diminishing returns while increasing risk. Sadly, financial corruption has played a huge role in getting us here. Never before in our history have Presidents, Fed Chairs, and politicians in general been able to exploit their power and gain massive wealth following their time as so-called public servants. A big part of our current problems is the elite top-down efforts to control our society has created a permanent government. Today an army of government workers, most un-elected have been empowered to nibble away at our rights.  

Bubbling up to the surface is the recognition the Fed has to shoulder a huge responsibility in pushing inequality higher. Powell has even gone so far as to claim there was little demand for loans below $1 million. Sadly, the same policies that dump huge money into larger businesses because it is an easier and faster way to bolster the economy give these concerns a huge advantage that devastates its smaller competitors.

The long-term ramifications of destroying smaller businesses hurts America in the long run. It eliminates competition, reduces opportunity, and over time fuels inflation. This drives my angst directed at companies such as Amazon and big tech. The policy of making people feel better so they spend more than they can afford is part of voodoo economics.  It has sent jobs abroad and increased our consumption of imported goods resulting in massive trade deficits. Good economic policy encourages personal responsibility and is rooted in saving not spending. Consumption does not create wealth, it creates debt.

 

(Republishing this article is permitted with reference to Bruce Wilds/AdvancingTime Blog)

Advancing Time: Japan's Future Remains An Issue Of Debate

Advancing Time: Japan's Future Remains An Issue Of Debate: The debate over the future of Japan continues. This is a complicated and interesting issue. Because of its small footprint, we often forget ...

Japan's Future Remains An Issue Of Debate

The debate over the future of Japan continues. This is a complicated and interesting issue. Because of its small footprint, we often forget the oversized role Japan plays in the global economy. Japan is the fourth largest economy in the world and a major exporter of finished goods. This makes it a big player in the global markets and for many years some investors have considered the yen a safe harbor in times of turmoil. 

In a post last Sunday here at AdvancingTime it was pointed out that the effects of higher rates will not end until they do. It could be argued that Powell has gotten a large part of his job done if he can simply hold the course. This means staying high for longer. This has the power to end the era of zero and negative interest rates across the world. The implications of ending this forty-plus-year trend are enormous. 

While I appreciate the opinions of Tom Luongo, I strongly disagree with him on the future of Japan. This is not personal, he does not know me, and we have never met. It should be noted that we both agree on the idea the euro is toast, he even talks about how much he expects it to fall. About 32 minutes into a video Luongo makes his take on Japan and the yen perfectly clear. 

Another issue is just how fast a fall in the yen or any currency could unfold. Today with all the ways to convert wealth to another currency or move it out of a country it could happen very very fast. If and when a currency falls out of favor and wealth is shifted across borders it seldom returns. When faith in a fiat currency is lost it is difficult to regain premier status.

One of the reasons I disagree with Luongo's stand on the yen is because it is possible to short the yen while at the same time buying Japan's stock market. The moderator goes on to say this. You can be bullish on the Japanese stock market while at the same time be bearish on Japan's currency. Stock markets can rise as a result of inflation and a falling currency is good for exports. The problem of course is that if the yen falls faster than the stock market sector you invest in rises, you lose.

Below are seven key reasons the yen is about to fall.

• Japan faces more inflation ahead and wealth has been exiting the country for years
• Japan imports a lot and the cost of them is soaring
  
• China's slowdown has hurt Japan's economy
  
• Japan has too much debt
• Japan has horrible demographics
• The BoJ owns much of the stock market through ETFs selling them would affect its market
  
• History shows that when under attack, a country cannot save both its bond market and currency
  

The idea that when investors in Japan's government bonds begin to believe inflation is not going away it would be logical for owners of  JGBs to move out of low-yielding securities and buy foreign bonds or equities. The moment the Japanese stock market fails to rise enough to offset a falling yen and inflation this will turn into a tsunami of money fleeing Japan and constitute the end of the line for those left holding both JGBs and the yen.

 Around 39 minutes into the video Luongo sort of concedes the yen could swing into problems. Of course, this is my interpretation of his words.  Going into 1 hour and 28 minutes Luongo mentions that when currencies slip, they often drop fast. Only time will tell how this unfolds. Still, until we see some clarity as to how Japan will deal with its debt problem, expect the debate over the future of Japan and its currency to garner attention.   

(Republishing this article is permitted with reference to Bruce Wilds/AdvancingTime Blog)

Advancing Time: Stocks Soar On Slowing Fundamentals, An Overreaction

Advancing Time: Stocks Soar On Slowing Fundamentals, An Overreaction: Stocks soaring on slowing fundamentals is an overreaction that can be explained in several ways. This recent market reaction reflects a huge...

Stocks Soar On Slowing Fundamentals, An Overreaction

Stocks soaring on slowing fundamentals is an overreaction that can be explained in several ways. This recent market reaction reflects a huge overreaction on the part of investors and computers hunting out shorts. This is seen in both stocks and the currency market. Big market moves like we just saw do not always make a trend or confirm a turning point but they do take a lot of pressure off markets being overbought or oversold. 

At this point, it is difficult to think the Fed wants to see these markets move further and undo the work it has achieved during the last eighteen months. Inflation has slowed but it is not dead and the seeds for a new wave have already been sowed. A peek at the National Debt Clock this morning shows that after hitting 32.5 trillion dollars just recently, we are already about to hit 33.7 which signifies we are moving far fast in the wrong direction.

The fact is, little changed last week and the game and effects of higher rates will not end until they do. It could be argued that Powell has gotten a large part of the job done if he can simply hold the course. This means staying high for longer. This has the power to an end the era of zero and negative interest rates across the world. The implications of ending this forty-plus-year trend are enormous. 

True price discovery has been lost during the debt explosion. What we are seeing is not about interest rates rising to slow a magnificent economy. What we are seeing is higher interest rates being used as a tool to get debt under control. When the debt collapses and defaults soar bad things happen. Bad news is not good news.

Too much debt and even worse, the expansion of it, is a problem. For as far as the eye can see unsustainable government deficits scream devaluations of fiat currencies. This only raises the issue of which currency falls fastest and hardest. An increase in the risk of defaults is in place, this includes not only individuals going bankrupt but companies and even nations. 

Yes, the markets may be celebrating a bit early. When all is said and done, little has changed. The dangerous game of accumulating wealth has more to do with avoiding huge losses while salting away gains than with markets violently swinging sideways. Wealth accumulation is a marathon and not a fifty-yard dash.

(Republishing this article is permitted with reference to Bruce Wilds/AdvancingTime Blog)

Advancing Time: Could The Fed Lower Interest Rates And Print Away?

Advancing Time: Could The Fed Lower Interest Rates And Print Away?: Interestingly, economists continue to reference the Great Financial Crisis of 2008 as if it were a depression. It is also important to note ...

Could The Fed Lower Interest Rates And Print Away?

Interestingly, economists continue to reference the Great Financial Crisis of 2008 as if it were a depression. It is also important to note that most of the issues causing the crisis have never really been addressed. By printing our way out of that mess, shifting and creating debt we have merely kicked the can down the road. It seems the endgame theory has been redefined and the game never ends, it just changes. 

It often seems the bubble is "always popping" but after two weeks it is back to business as usual. This is evident in the fact ideas of debt reduction now include talk of a debt jubilee and it is becoming more normal for people to advocate guaranteed basic income as the answer to society's woes. Universal basic income or UBI is a direct cash benefit from the government that provides people with money to support their basic needs regardless of their employment status.

 

While unlikely, we must consider that at any time the Fed could lower interest rates and take us down the same path as Japan. Yes, the Fed could lower interest rates and print away as an answer to our problems. The problem with this is it results in a slew of new problems. While this seems unlikely as long as Powell remains in power, if he would be removed from the equation, things could rapidly change. 

 

Beware Things Can Get Twisted!

The system that we live under is essentially closed and such systems are generally more rigged versus open systems. Closed systems are in a way a trap that is very difficult to get out of. An example of this is that gold ETFs act more as a derivative for gold, and fiat currencies across the world act as a derivative for the dollar. These derivatives are not as valuable as the real thing when you get right down to their bottom-line. Derivatives are more of a promise or a link to the real thing.  

The idea of higher for longer has not crashed the economy. We can only hope it will result in a re-balancing over time. This does not mean the bears are wrong or the bulls are right, it sort of means we will putter along. An article came out after the last Fed meeting touting how Powell was essentially saying the Fed is done raising rates.  

 

Is the story of the 2022 and 2023 rate hikes behind us? Not by a long shot. What some market watchers may be forgetting is that the duration factor, or how long they are kept at this level is as important as the rate itself. Also, the full effect of these rate hikes has yet to work its way through the economy.

 

The interest rate story intersects with several other important stories and factors that will shape our future. For example, many people in the inflation camp see at least 5% inflation will stay with us for most of the next ten years. Taxation is another, direct or indirect, life is full of hidden taxes. Governments, banks, and businesses all benefit from taking advantage of us by shifting costs and then nibbling away at us. 

Also, we would be naive to discount soaring labor costs. several agreements with huge unions have resulted in raises in the 30% area. This jump makes it difficult to think the nearly 25 million government and public sector workers across America will not be soon banging on the drums for huge wage increases. then there is the issue of geo-political problems everywhere, but that is a subject for another time.

Even if the rate hiking cycle is coming to an end, the fact that if inflation does not remain contained, new issues will emerge. The glorious idea capital controls will bring about a glorious future should be viewed with suspicion. As the world reserve currency, the dollar still carries a lot of weight in this never-ending game. We can only hope that weight is not squandered and that more is done to correct the unsustainable economic path of piling on debt upon debt the world has taken.

 

 

(Republishing this article is permitted with reference to Bruce Wilds/AdvancingTime Blog)