Confidence, confidence and more confidence is necessary for a successful economy to continue to perform on a consistent and growing trajectory. Of course a fair system with transparent rules, stable, productive and necessary government spending and a responsible and effective monetary policy is necessary as well. But without confidence, it’s difficult to get the constant investment and reinvestment in labor, technology and assets necessary to continue economic growth without disruptive variance. A plunge in confidence can expose cracks in what seems solid economic foundations resulting in deep and prolonged recessions, depressions or outright defaults.
As I was recently driving down the Eastern Seaboard, signs of significant economic growth from the last 10 years is clearly visible: large swaths of new residential and commercial construction, roads and bridges are frequently seen especially around the Washington DC area. The highways are packed with endless lines of cars and people going about their lives like a colony of worker ants – doing as expected without questioning how the world works.
Douse us with more whisky, more beer, more cannabis – dull our senses we will never question the system we live. In fact, give us more Sake and more Aquavit too please as this is not just a US issue, but a global one as well. We will keep having more babies, more distractions and the predisposition to accumulate more stuff. This tunnel vision of preoccupation will keep us oblivious to our surroundings and all consumed in the moment of life. Confidence abounds.
But does anyone actually understand the opaque symphony of financial markets and the US economy that has created and extended this Goldilocks economy?
The progress of the US economy over the last 10 plus years has been on a trajectory that’s not too hot to create inflationary problems and not to cold that the unemployment rate is now at the lowest experienced.
But when you look under the hood at the US’s economic engine, you see parts and machinery that has never previously existed, that has never been tested and that no mechanic can explain exactly how it works. The car seems to be driving fine, who cares how it works… right?
Since 2008, monetary policy has been the most accommodative ever in the history of the US and continues to be so. The Federal Reserve purchased approximately 5 trillion of bonds with money created out of thin air to assist with the financial crisis of 2008 and still retains most of those purchases. Interest rates are still pinned at rates lower than during the Great Depression. The resulting asset inflation from this excessive monetary policy has driven equity markets, debt markets, real-estate and a plethora of other asset classes to lofty valuations. However, all of these extraordinary policies have only resulted in average economic growth. And the potential risks, or costs of these policies vary from impotent monetary policy reaction for future economic downturns to extreme market volatility and systemic debacles.
Jamie Dimon, J.P. Morgan Chase CEO echoing these sentiments of unforeseen potential systemic issues was quoted at the World Economic Forum in Davos, Switzerland saying: “The only thing I have trepidation about is negative interest rates, QE, and the diversion between stock prices and bond prices and yield and stuff like that”. “It’s kind of one of the great experiments of all time and we still don’t know what the ultimate outcome is.”
Fiscal policy is also in uncharted waters. We are experiencing the highest government spending with lower tax revenues resulting in ever expanding deficits that is assisting current economic progress. Again, at what cost? We now have the largest debt EVER. What if foreign investors that own half of our outstanding debt ever ask for their money back – who would fund the difference? (Rhetorical question – the Federal Reserve of course – QE4.) But could a run on our debt markets lead to a precipitously declining dollar, resulting in uncontrolled inflation and limiting the Federal Reserve’s policy – or even forcing them to raise rates just when the economy needs lower rates?
We are experiencing the most extreme monetary and fiscal policies ever pursued and the current environment seems to be a balanced average outcome. And we are not alone. In this interconnected global economic and financial world, most developed countries are in the same position. You have to ask – are the opaque and never before pursued policies sound and what are the costs.
Let’s be honest to ourselves - the most extreme policies ever pursued will also have the most extreme costs. As excessive monetary and fiscal policies have extended our business cycles from what use to be a couple of years of expansion before a shallow recession to now decades of expansion ending with dramatic recessions, the costs to these policies may result in systemic issues and a bankrupt nation.
With such extreme costs hidden in plain sight, it is now more important than ever to ensure consumer confidence remains at healthy levels. A reduced level of confidence has a strong history of leading to a jump in the unemployment rate and recessions.
As shown in the graph above, the US Confidence Index is a reliable index that negatively correlates with the unemployment rate experienced in the US.
As such, any reduction in confidence must be avoided at all costs or a self-feeding cycle of lower confidence can trigger these extreme embedded costs and lead to economic disaster.
Well that’s concerning. One of the most prolific generators of confidence – both positive and negative – come from our politicians. As our politicians are bent on destroying their political rivals, they often play off of our emotions resulting in diminished confidence to further their political ambitions. These politicians have no clue that being so cavalier with confidence can lead to such extreme embedded costs. Or worse, some are cognizant of these costs and feel these are acceptable risks to play with.
And the political weapons being used by our political parties continue to get more destructive and can result in unintended casualties. As we go into the reelection season, I expect above average economic performance will limit a negative economic narrative and focus more on positive economic outcomes each party can foster. However, once the election cycle is over, I expect the gloves to come off and doom and gloom accusations to be launched at each other. This will be playing with confidence fire and may lead to uncontrollable downside to all asset classes trading at historically frothy levels and, eventually, the economy.
Recently, the negative actions of our politicians have been largely ignored. The media has been consumed with impeachment stories and has not fostered economic and financial fears as topics of the day. And as pawns in the perverse political game of life, we have no ability to change the drivers of confidence and avoid the resulting outcomes. All we can do is live through the business cycles, prepare for the inevitable and hope the costs experienced are low. Maybe responding monetary and fiscal policy actions that offset the economic damage from the next downturn in confidence will be deployed in time and the costs will be minimal.
Living in the moment, the current expansion and conditions feel real, tangible and never ending. However, current government spending and manipulation of interest rates by central banks cannot last forever. This business cycle will eventually end with a recession. What will determine if the next downturn is at best a short with a quick upswing for another extended business cycle or at worst a systemic downturn that leads to a Greek style bailout will be confidence. Just because we are pawns in this game of life scripted by our politicians doesn’t mean we can’t remove our blinders and at least understand how the game is played.
by Michael Carino, Greenwich Endeavors, 1/23/2020
Michael Carino, CEO of Greenwich Endeavors, is a finance specialist with over 25 years of experience. He has owned financial firms with roles including portfolio manager, trader, accountant, risk manager and treasury manager. He typically has positions that benefit from a normalized bond market, higher yields and value investments.