It’s the markets, stupid

Friday, 16 March 2018
Melbourne, Australia
By Vern Gowdie

  • The tools of fools
  • Where the markets have gone, the economy has not followed
  • Powell’s make or break moment is coming

In March 1991, President George HW Bush’s approval rating was 90%.

After the ground invasion of Iraq, Americans gave him the ‘thumbs up’ for a job well done.

However, the upbeat mood proved to be fleeting.

The sluggish recovery from the 1991 recession weighed heavily on US households and social mood.

In the lead up to the 1992 Presidential election, James Carville, the campaign strategist for Bill Clinton, picked up on Main Street’s discontent.

To ensure everyone stayed on message, Carville coined three simple messages for Clinton’s campaign team:

  1. Change versus more of the same.
  2. Don’t forget healthcare.
  3. The economy, stupid.

It was the last one which was altered to ‘it’s the economy, stupid’ that voters related to.

And who was to blame for it? George HW Bush.

Within the space of 21 months, President Bush’s approval rating plunged to 36%.

The first-term President was voted out of his job in November 1992.

The message from voter land was not lost on those in power — politicians and central bankers alike. To paraphrase Mario Draghi ‘we need to do whatever it takes to avoid economic hardship’.

The Federal Reserve, initially under the chairmanship of Alan Greenspan, embarked on an ambitious experiment to turn the business cycle — one of expansion and contraction — into an ascending straight line. Growth with negligible downside.

Greenspan’s successors, Bernanke and Yellen, were disciples cut from the same cloth. Growth, growth, and more growth.

In November 2010, Ben Bernanke wrote this in The Washington Post:

Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

With hindsight we know that what started out as light touch tinkering, and ended up as heavy handed tampering, does not work.

As Nassim Taleb (author of The Black Swan and Antifragile) and Mark Spitznagel wrote in The Financial Times (emphasis mine):

Monetary policy [interest rate settings; QE; buying and selling assets] has always been dangerous. Alan Greenspan, former Federal Reserve chairman, tried playing with the business cycle to iron out bubbles, but it eventually got completely out of control. Bubbles and fads are part of cultural life. We need to do the opposite to what Mr Greenspan did: make the economy’s structure more robust to bubbles.

More after the markets…


Overnight, the Dow Jones Industrial Average climbed 115.54 points, or 0.47%.

The S&P 500 lost 2.15 points, or 0.08%.

In Europe, the Euro Stoxx 50 index finished up 23.15 points, or 0.68%. Meanwhile, the FTSE 100 rose by 0.10%, and Germany’s DAX rose 107.82 points, or 0.88%.

In Asian markets, Japan’s Nikkei 225 fell 123.46 points, or 0.57%. China’s CSI 300 is also down 0.22%.

In Australia, the S&P/ASX 200 rose 27.00 points, or 0.45%.

On the commodities markets, West Texas Intermediate crude oil is US$55.14 per barrel. Brent crude is US$65.04 per barrel.

Gold is trading for US$1,332.70 (AU$1,712.18) per troy ounce. Silver is US$16.62 (AU$21.35) per troy ounce.

Bitcoin has fallen slightly. One bitcoin is worth US$8,038.16.

The Aussie dollar is worth 77.84 US cents.

The tools of fools

Lowering interest rates and increasing debt levels — the so-called solutions to our financial morass, have only made a bad situation worse.

These are the tools of fools. Harsh words? Perhaps. But only a fool would do the same thing over, and over, and over again and expect a different outcome.

How many more destructive bubbles do these people need to create to finally realise and accept the folly of their actions?

This is insanity. But, what’s even more insane is that (just about) everyone nods and agrees with the pursuit of a policy that has proven — not once but twice — to be seriously flawed.

The following chart is of the Dow Jones Index.

Look at the two previous attempts — 2000 and 2007 to align rising financial markets with economic expansion.

Both ended badly.

The last one was so bad, the IMF (International Monetary Fund) said at the time (emphasis mine):

The financial market crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression, inflicting heavy damage on markets and institutions at the core of the financial system.

chart image

Source: Macro Trends
Click to enlarge

The latest parabolic rise in the Dow is due to the ‘mother of all’ stimulus efforts.

The current market dwarfs 2007.

And, if this over-valued, over-bought, and over-hyped market was not dangerous enough on its own, global debt has increased by a further US$90 trillion since 2008.

What a powder keg we’re sitting on.

Where the markets have gone, the economy has not followed

With all this stimulus and asset price reflation, you’d think the US economy would be turbo-charged.

Not so.

The US economy has failed to respond in kind.

While the US share market has soared higher since 2008, the economy has struggled to average real (after inflation) growth of 2% per annum…around half the rate of the 1990s.

chart image

Source: Statista
Click to enlarge

We have reached an interesting juncture in financial markets.

The US market is showing signs of teetering (possibly on the verge of entering a massive bear market) and the Fed has a new chairperson, Jerome Powell.

When (not if) the US market succumbs to the gravitational pull of reality, will Powell follow blindly in the footsteps of Greenspan, Bernanke and Yellen? Or will he be his own man?

On 26 February 2018, Bloomberg published an article titled ‘The Rules of the Game Are Changing on the Fed’.

The article (finally) raises questions about continuing with the Fed’s flawed strategy. Here’s an extract:

Economies are becoming increasingly driven by real and financial asset prices…

Prices that matter the most now are tied to the financial cycle. Real and financial asset prices have advanced at relatively high rates, becoming unhinged from prices tied to the economic cycle. Prior to the 1990s, the cumulative gains in real and financial asset prices more or less paralleled growth in household income. Yet during the economic upturns of the 1990s, 2000s and the current cycle, the cumulative price gains have outpaced income gains by 25 percent to 30 percent. These gains have engendered large increases in wealth, lifting the ratio of household net worth to income to higher highs, and in the process created a new source of purchasing power and collateral to support borrowing and spending.

The Fed’s stimulus efforts are aimed fairly and squarely at creating the wealth effect. Make people feel wealthier and they are more likely to borrow and spend.

That’s been their grand plan for economic growth.

What could possibly go wrong?

From the same Bloomberg article:

History shows that this newfound source of liquidity can readily disappear, and the fallout in the real economy can be severe, as is evident from the long and deep economic downturn of 2007­–2009.

Rational and reasonable people who possess a degree of intelligence, when confronted with the fallout from an error of judgement, would analyse what went wrong and learn from their mistakes. 

That’s how society has progressed throughout the centuries. And, thankfully we did. Otherwise we’d still be drinking radium (radioactive) water to cure everything from arthritis to impotence.

However, central bankers are a special breed.

They are so wedded to their crackpot theory — the prescription of more debt to cure a debt crisis, that they’ve convinced themselves and almost everyone else that this is sound economic policy.

They’re so intelligent, that they are dumb.

Again, Bloomberg article points out the obvious…

Jerome Powell, the new Fed chairman, and other policy makers must recognize that the price-targeting regime — along with the asset purchase program — has directly and indirectly created an unhealthy balance between the economic and financial cycles so much so that it is endangering the Fed’s natural role of financial stability.

Powell’s make or break moment is coming

The Fed’s excessive levels of stimulus temporarily create the illusion of growth…but with each bursting of the bubble, the system becomes more unstable.

The Fed’s strategy has been to build a bigger bubble on the faulty foundations of the previous one.

The latest bubble is, in terms of breadth and height, without peer.

Property. Cryptos. Shares. Loss-making tech companies. Bonds. Art works. They are all at insane levels.

Just to standstill, these markets need more of the same juice.

But the Fed is making tentative moves to withdraw the props upon which this bubble has been built.

Slowing raising interest rates. Selling (rather than buying) assets.

The new Fed chair has declared that there will be no change to the gradual withdrawal of stimulus.

We’ll see.

When the market gets a serious case of wobbles (falling several thousand points), Powell will be faced with his make or break moment.

Will he stand firm and let the market find its own level or will he resort to the heavy-handed tampering of his predecessor?

My guess is the latter.


The current first-term President has taken much (OK, all) of the credit for the US share market’s record-breaking run.

When the next Presidential election campaign rolls around, and we’re in the grip of a severe bear market and recession, the Democrats will take a leaf out of James Carville’s play book and say…

‘It’s the markets, stupid.’

And Powell will be wedged by the Republicans and the Democrats.

Both will want the market to go higher (again) to create the illusion of growth.

However, I suspect there’s not enough QE or negative interest rates left in the world to achieve that objective…at least not in the short to medium term.

There is debt to be expunged. Assets to be written down in value. Companies to go bankrupt.

Trillions of dollars will be wiped off balance sheets — government, corporate and private.

The Fed is faced with a situation of ‘third time unlucky’.

The only way to avoid the wholesale write-offs that are coming, is to be invested in the one asset class that has not been included in the ‘everything bubble’…and that is cash.


Vern Gowdie

Editor’s note: The above article is an edited extract from Vern Gowdie’s The Gowdie Letter.