Why this is the Longest Ever US Economic Expansion
This week saw yet another record fall in what is sure to be an economic era full of lessons for future generations to study. The US is now in its longest ever cycle of economic expansion, some 121 months, surpassing the previous record of 120 months between March 1991 and March 2001 that ended in the NASDAQ dropping 80%.
Since 1854 the average length of such cycles is just 40 months making this milestone all the more remarkable. There are a number of contributing factors, including the fall of the more ‘boom and bust’ dominance of agriculture and the dramatic changes brought about by the effects of globalisation. However a quick glance at the chart below also highlights the effects of having a system without the discipline and underpinnings of a gold standard. With a gold standard, if you had the sort of currency devaluing practices now rampant amongst all the world’s major central banks, gold would have flowed from their coffers at an alarming rate. Indeed it was this phenomenon that had Nixon end the gold standard in 1971.
Clearly more debt buys longer periods of expansion and now this latest cycle has the added kicker of an unprecedented amount of central bank stimulus in the form of monetary expansion and negative interest rates with the sole aim of avoiding the unavoidable – a recession. Every cycle must end in a recession and the cost of avoiding this next recession has seen the greatest amassing of sovereign debt in history.
The chart above is just the US but we have seen the same (and more in relative terms) from Japan, Eurozone and China.
The problem with this cycle is that it has also been one of the weakest in terms of actual economic growth. The above chart highlights the extent to which this expansion has been driven by central banks and not fundamentals. As the authors, Deutsche Bank state: “Liquidity and intervention has been enormous and this has flowed into assets, not the economy.”
You can also see from the chart above the Fed’s attempt to quietly reduce its QE amassed balance sheet via QT whilst they also started hiking rates. As we now know, a market based predominately on central bank stimulus does not take kindly to the candy being taken away and they had to pivot and start easing again. That surely does not bode well for how this all ends.
This week we have seen US bond yields trend lower, the German 10yr bund dip below the ECB’s -0.4% deposit rate for the first time ever, the ECB announce that the dovish IMF chief Christine Lagarde will replace Draghi (promising even more stimulus to come) and the amount of negative yielding sovereign debt extend to $13.4 trillion. Trump keeps tweeting for the Fed to cut rates to lower the USD and compete with Japan, Euro and China who are devaluing their currencies against the [his] USD. This is a race to the bottom with only one inevitable consequence. But for now the short sighted sharemarket is going hard, reaching all time highs. Just check out the so called ‘jaws of death’ now!
Finally, and very topically, Trump has announced his nomination of Judy Felton to the Fed. Whilst this is no doubt off her stating she would lower interest rates to 0% in one of two years (music to his ears), just back in April she wrote an op-ed in the Wall Street Journal titled “The Case for Monetary Regime Change”. Spot the contrast to that outlined above…
“Since President Trump announced his intention to nominate Herman Cain and Stephen Moore to serve on the Federal Reserve’s board of governors, mainstream commentators have made a point of dismissing anyone sympathetic to a gold standard as crankish or unqualified.
But it is wholly legitimate, and entirely prudent, to question the infallibility of the Federal Reserve in calibrating the money supply to the needs of the economy. No other government institution had more influence over the creation of money and credit in the lead-up to the devastating 2008 global meltdown. And the Fed’s response to the meltdown may have exacerbated the damage by lowering the incentive for banks to fund private-sector growth.
What began as an emergency decision in the wake of the financial crisis to pay interest to commercial banks on excess reserves has become the Fed’s main mechanism for conducting monetary policy. To raise interest rates, the Fed increases the rate it pays banks to keep their $1.5 trillion in excess reserves—eight times what is required—parked in accounts at Federal Reserve district banks. Rewarding banks for holding excess reserves in sterile depository accounts at the Fed rather than making loans to the public does not help create business or spur job creation.
Meanwhile, for all the talk of a “rules-based” system for international trade, there are no rules when it comes to ensuring a level monetary playing field. The classical gold standard established an international benchmark for currency values, consistent with free-trade principles. Today’s arrangements permit governments to manipulate their currencies to gain an export advantage.
Money is meant to serve as a reliable unit of account and store of value across borders and through time. It’s entirely reasonable to ask whether this might be better assured by linking the supply of money and credit to gold or some other reference point as opposed to relying on the judgment of a dozen or so monetary officials meeting eight times a year to set interest rates. A linked system could allow currency convertibility by individuals (as under a gold standard) or foreign central banks (as under Bretton Woods). Either way, it could redress inflationary pressures.”