Why has the economy been stagnant since 2008? Not the stock market…the real economy: real growth, higher wages, etc. Because we never let the system clear itself of waste, excess, inefficiency and poor investment decisions. I think a good analogy to explain this concept is to think of the economy like a balloon. In order to inflate the balloon you take a deep breath and begin blowing into the balloon – the balloon expands. Eventually you run out of breath and need to pause to inhale again. When you pause, the balloon temporary stops expanding and possibly a little air might even sneak its way out if you don’t pinch the end of the balloon tight enough (oh the horror!!!). But, by pausing and taking a deep breath, you’re refreshed and ready to inflate the balloon through the next stage of expansion. If you never pause to take that breath, you ever so slowly run out of air in your lungs until you’re struggling to get any last bit of air you can into the balloon, all while the pace of expansion slows to virtually zero. So, the pause is necessary in order to prep for the next stage of growth/expansion.
Somewhere along the line, most likely following the 1987 stock market crash known as Black Monday, an economic recession became the worst thing imaginable in the eyes of our policy makers. The Fed chairman at the time, Alan Greenspan, was new to the position and took it upon himself to save the day. Everyone cheered and he decided it would be his job to never let the economy slow down again. Bernanke then followed suit in the 2000’s after taking the reins and continued the viewpoint that the Fed can use monetary policy to distort steer the economy so we’re always on a smooth trajectory upwards. “We’ll lower interest rates, ease monetary conditions, increase the money supply… no problem,” so the thought process goes. Well there is a problem with that: human nature. In theory, a smooth, constant gradual increase sounds great but in reality the economic system is highly complex and does not move/react in a linear fashion. And as the Fed has tried to continually support the economy over the last 30 years, they’ve created ever-growing distortions which then require even more extreme monetary policy the next time around (even lower interest rates, larger QE programs, etc.) to prevent the next slowdown. The main issue is that we never let the system clean itself out of all of the malinvestment made during the prior boom, and believe me, there are always poor decisions as late-comers try to cash-in on a boom. If you don’t let the natural cleansing process occur, the economy is stuck with excess that drags on future growth. The harder it is to generate growth, the more the Fed feels they need to ease monetary conditions, which only exacerbates the problems because you make it easier for the companies that have made poor decisions to stay in business which eventually creates a zombie like system of bad loans and inefficient companies just hanging on to service debt payments (this is what is occurring in the energy space right now and it’s the reason production has not fallen despite oil falling from $100/barrel to $30). It’s a terrible feedback loop that we’ve been stuck in for far too long now. What it inevitably creates is a system where investors are starved for real growth so they’re willing to pay enormous multiples for anything posting any sort of growth, despite operating at a loss (think back to the tech boom of the late 90’s). Rest assured dear clients, we do not participate in this kind of craziness.
Here’s a fantastic article from last week by Josh Brown discussing this predicament and the inefficiencies with which the economy is currently plagued. Enjoy: Click here to read.
-Nick