Just as the earth needs rain, we need contraction periods in economy. We explain why.
Good morning! I’m Austerity Jones, and I am here with C Thomas Printer and he is going to channel his inner Lance Armstrong today.
C Thomas: Good morning Austerity. I’m going to do what? Lance Armstrong?
Austerity: You said you were going to talk about cycles.
C Thomas: Oh boy, and you think I am bad? No more comments from you after that. But Austerity is right. I would like to talk about cycles: not bi-cycles which are cyclically ambiguous, but cycles which repeat over and over again. Every year, the sun’s position over the earth travels from directly over the tropic of cancer in June to directly over the tropic of Capricorn in December. With it comes more or less heat and it brings about the seasons. From the warm summer and long days comes cooler temperatures, and less light leading to the leaves falling off the trees, and the cold winds leading to winter snows that seem to linger. Just when it seems like the winter will never let up, the sun breaks and the warm chinook winds blow, bringing with it the warmer temperatures leading to the snow melt and then the greening of spring which leads back into summer. Now, not every year is the same, but the underlying cycle is the same. Some winters are mild, and others have a lot of snow, some summers are very dry and low in precipitation leading to droughts, but eventually the rains and the snows come and the cycle continues. Despite the non-stop change, there are the underlying cycles that are consistent, but we simply don’t know the specific timing.
The market cycle is very similar to the seasonal cycle. Markets which are flourishing and awash in easy credit and profits lend themselves to foolish investments, over hiring and overinvestment. This leads to over supply as demand is high, but ultimately the balance between supply and demand tips over into over supply just as if summer continued forever we would have droughts and fires. The markets need precipitation as well and it comes in the form of business contraction. Soon the cold winds blow and then businesses are forced to contract further by laying off workers and cutting investment as margins are constricted, profits fall and losses mount and demand has effectively been lowered below supply. For some less efficient players this might be bankruptcy and going out of business. This washes the market of inefficiencies and allows the better players to utilize the leftover capital in ways that are more productive. When the business winter has gone and washed away the excess supply, the contraction can end and expansion begins again and there is often a rebirth of new industries, reorganizations of capital and players, and credit expands helping businesses grow which leads to a green environment – monetarily – just as spring does for our landscapes.
Now, we have not yet gotten so powerful that we have managed to stop the earth from making its advance and retreat bringing about the seasons, but we have attempted to short circuit the market cycle. We have tried to have an everlasting summer. When things start to get a little chilly, we get a look at fiscal winter, and then we go back and restart our video game and choose the summer setting again. Like we said, if you do that, you risk spectacularly bad outcomes like land that can’t properly absorb precipitation, and forest fires which lead to flooding and catastrophe.
Now as Katherine Hepburn said to Rooster Cogburn “If thine intent be pure.” I don’t doubt that the intent be pure for the financial authorities who try to save us from fiscal winter. They bailout bad businesses, they provide credit for those that would file bankruptcy otherwise, and they ensure that credit is available for those that want to continue to grow. Well the problem comes when this continues for some time, we have lots of inefficient businesses and the large losers are the consumers who want efficiency. We want productive enterprises to grow and unproductive enterprises to fail. We want true competition that betters our lifestyles by offering us more bang for our buck when it comes to purchasing power. This is the essence of a capital based economy, and what allowed this country to grow so rapidly in its first 200 years. The sun is to seasons what gold was to a market based economy. Both yellow, both ever present, and both a regulator on how much heat could be applied. When the governments spent too much the people realized their paper wasn’t worth much and traded in the paper and held gold. This was and always has been a sign that fiat currency wasn’t real money, it was just a note that said- this can be redeemed for real money. That’s why our currency used to be directly redeemable for silver or gold. With silver being the cheaper money for the masses and gold the money for the government.
In 1971, the US basically defaulted by going off the gold standard. Our fiat currency was backed by the redeemability of anyone foreign and domestic to exchange notes for gold, but the spending of the Great Society programs, Vietnam War, and even the race for space had far outshot our government’s income and the gold standard was a bothersome regulator on spending.
In 2022, central banks have purchased 673 tonnes of gold this year which is the highest level since 1967 according to the World Gold Council. As David Fickling wrote for Bloomberg on Sunday, “In a world where you can trust no one, it makes sense to bulletproof yourself with metal.” He was referring to gold of course, and it particular to the US freezing the foreign reserves of Russia in February. Foreign reserves are purchased with the nation’s current account surpluses. Countries that export natural resources like Brazil and Russia have often run surpluses just like countries that export manufactured goods like China and Germany. These surpluses usually get settled with foreign reserves and the US dollar was the pristine collateral that they have used for the better part of the last century to settle these accounts and while the dollar is still used predominantly, the percentage of foreign reserves being held in dollars has dropped from 66% to 59% in just 6 years. It’s been 16 years since our total US debt was around 8 trillion dollars when Nobel prize winner for economic crises Ben Bernanke took over the Federal Reserve. In the last 6 years, it has gone almost parabolic jumping from $19 trillion to over 31 trillion. Is it any wonder that people are starting to trade in paper for gold? What’s interesting is that it is the people and governments around the world that are starting to reduce dollar holdings and buy gold. The dollar is backed by the full faith and credit of the United States of America. We might still think it is reliable, but if the rest of the world doesn’t, what happens when we live in a global connected world and run the world’s largest current account deficit? So what happens when our place in the global financial arena seems to be cooling, the leaves or wheels in this case seem to be falling off? The cycle would identify us as the weak player, the player that only consumes and doesn’t produce items of value, and we should be washed out and bankrupt. That would signify winter is coming. When we have a debt to GDP of over 120%, the largest current account deficit in the world, and a world quickly tiring of us on a bully pulpit, oh yes, the fiscal winter is coming. Remember, the cycles always repeat themselves. To be continued…
Sincerely Yours,
C Thomas Printer
On this date in history
252 years ago to be exact, George Grenville died. He advanced the English policies of taxing and then overtaxing the American Colonies leading to the American Revolution. Thanks George!
This week’s financial tip
Get a grocery loyalty card. While you are saving some money and putting in into your savings account and starting with a 3 month emergency fund, it is imperative that we honor the Benjamin Franklin concept of a penny saved is a penny earned. You are going to have to buy food so there is no reason to not save a few bucks every trip while doing so. If you don’t want to fill out an application and give your information away, then just ask for a card and use it. These dollars will add up quickly. Look at your grocery bill and it will be a nice reward for you. Keep saving.
Also born on this date
The man that brought us Happy Days: Garry Marshall. He brought us future stars like the Fonz, Henry Winkler, Robin Williams as Mork, and Julia Roberts as the Pretty Woman. He is the brother of director, Penny Marshall who became a star when Garry had her star in his 70’s series Laverne and Shirley.