Nobody knows for sure exactly why the business cycle occurs, why the economy improves and then declines. About once every lifetime though, the normal downturn in the business cycle simply falls off a cliff, and doesn’t improve. A very deep and prolonged economic slump begins, and lasts for years. Few if any anticipate the impending depression.
I have been thinking about and studying this topic for nearly two decades, and I postulate that we may be on the verge of another economic depression which will be deeper and longer than anything experienced in our lifetimes.
I am aware there are many economists out there who believe the economy is completely managed, and that any slump can be countered with both fiscal and economic policy. However, I would suggest that will not occur this time, for both practical and political reasons.
The first question to answer is why, during some business cycles, does the economy fail to recover? In every major depression I have studied, the recovery fails because the banking system itself breaks. We nearly saw this happen during the financial crisis of 2008-2009. In the Great Depression of the 1930s, banking failures were very common, just as they were in the major depressions prior to the Great Depression. With an ineffective banking system, the economy cannot heal.
So the next logical question would be, what causes the banking system to break? To that question, I postulate that the banking system breaks because of extreme wealth disparity. A position we find ourselves in again after 80+ years.
Unfortunately in capitalist systems, discussing wealth disparity is taboo because the solution is often to redistribute wealth. I will discuss that topic later, but I will also point out that economic depressions are highly efficient at redistributing wealth. Unfortunately, it is at a lower level of wealth for everyone involved!
The third question then becomes, how does wealth disparity cause the banking system to break? Imagine for a moment a small society of 100 people. They all start with equal wealth. There is a central bank lending money into this small economy. The business cycle happens, and during the downturn, 7 people become unemployed. Remaining unemployed, their wealth shrinks, for some more than others. During the recovery, 5 get jobs quickly and rebuild their lives. 2 never fully recover, and their original wealth is shifted somewhat to the other 98. With each and every business cycle wealth is shifted to fewer and fewer winners. After enough cycles, 2 have nearly all the wealth, and the other 98 are in debt up to their eyeballs, barely scraping by.
It is important to understand that banks make money by lending money. Continuing the example, the bank then goes to make a loan when wealth disparity hits the extreme. The lender looks over the population and sees 2 people who are qualified to take on debt. Of course, those 2 are so wealthy, they have no need to borrow. The other 98 are not really qualified to borrow, as they have little to no wealth to properly secure a loan. They also have little to no ability to increase their monthly payments, even if interest rates were zero. The bank unfortunately has to lend money to make money! The solution is to lower the lending standards so that the 98 can then qualify for loans. When this happens, the economy will slowly recover. The recession is usually deeper than previous, while the government goes deep in the red to help the recovery. Capacity for help with another such incident is severely diminished, as is the government’s willpower to step in again.
During this recovery, there is an unease among everyone. It is a slow recovery. It will seem as though everyone, businesses and individuals alike, have significant debt. The debt absorbs most of the available income, thereby inhibiting savings. Since most people are in the same situation, it kind of feels “normal”. At the same time, anxiety is quite high. The anxiety and discomfort may even encourage political extremes.
Time continues, and the business cycle happens. Another downturn in economy begins. All those loans made to the 98 sub-par borrowers now go into default. En-masse, the banking system breaks from all the poorly secured bad loans. Even the good loans go bad because the assets securing them decline in price more than anyone anticipated.
The government, still overwhelmed from the prior downturn has little capacity left to respond. The banks cannot respond. So the economy spirals down. The financial assets of the wealthy evaporate. The homes and cars of the average Joe are foreclosed. Prices spiral in deflation as assets everywhere are put on the block so that people can just pay bills. Eventually, the dust settles, wealth is again more equal, but at a much lower level, and the process begins anew. This purging of debt can take years.
Can it happen again? It’s not a question of “if”, but rather “when”. At some point, there WILL be another great depression. Furthermore, the signs will NOT be obvious! Take a look for a moment at what the economy was like in 1929……
- Manufacturing efficiency was rapidly increasing
- Factory payrolls in September 1929 were at an all time high
- Freight car loadings were at an all time record high
- Productivity increases were running at a strong 5.3%
- 1436 firms announced increased dividends in the first 9 months of 1929
- The stock market was rising on the back of strong earnings reports
- Price-to-Earnings ratios were high, but not insanely high. (they are higher today!)
Few if any would have guessed that a year later, the economy would have fallen off a cliff. But it did!
Let’s look at the charts of wealth disparity. A peak in wealth disparity occurred just prior to the economic collapse of 1929. In fact, it has peaked just prior to nearly every major depression. The more wealth one has, the more they can command more income, thereby accelerating the disparity trend. Wealth disparity is peaking yet again! And so is income disparity.
Looking at the numbers, the economy today appears strong. But those numbers are “average” numbers. If the economy grows at 2%, what isn’t stated is that the entire 2% growth went to a few billionaires! Everyone else is nervous, in debt up to their eyebrows.
We keep hearing the economy is strong in 2017. At the same time, these are some of the headlines…..some arriving in today’s news:
- Union Pacific lays off 750 workers (slowing rail shipments)
- Retail stores are closing at an epic pace (April 2017)
- Auto sales are slowing and upheaval is next (May 2017)
- The Illinois debt crisis (July 2017)
- Puerto Rico files for biggest ever municipal bankruptcy
- New housing bubble in 2017
- Auto leasing at all time high
- Stock P/E ratio nearing record high
- Bond prices in largest bubble going back to the year 1800 (Alan Greenspan, Aug 2017)
The last bullet is a major concern because the bond market is nearly 100-times the size of the stock market. Bond investors are usually conservative, and act quickly to protect their capital. If they sense the bond market is about to implode, they will quickly pull their money from bonds, which in turn will spike interest rates, which will cause a severe downturn in an overpriced stock market. Such destruction of financial wealth will reverberate to the real economy, and layoffs will be rampant. Since the average American carries significant debt, defaults will be quite large, and banks will pull back on lending to protect themselves. This further shrinks the economy.
Meanwhile, Washington DC, still reeling from the last recession, has no political appetite to rescue banks or the economy again. At the same time, the Federal Reserve is looking to shrink their $4.5 Trillion balance sheet, not grow it. So the money supply will be shrinking as well. Just today, they announce another likely interest rate increase for the FOMC meeting in September.
The excessive debt permeating our society today, brought on by growing wealth disparity, is about to implode. The sheer quantity of it, and the speed with which the economy will reverse course will catch most by surprise…..just as it did in 1929. Washington DC will not react, and the Fed has no bullets left to help.
What if wealth were redistributed? Believe it or not, there are proposals to do just that! There is growing talk of a UBI, a Universal Basic Income. In the United States, it may equate to $1000/mo per person. Enough to eat while living in a tent! The issue I have with the UBI idea is that the billionaires proposing it will protect their wealth, while the least wealthy people will have what little they own redistributed to each other. The wealth gap would remain intact.
As I stated earlier, the most efficient way to redistribute wealth is with a major economic depression. The telltale signs point to another one occurring very soon. Should we see a significant stock market crash this autumn, it will likely be followed by a significant economic downturn within 6 to 9 months. As that starts, I will be sure to post further updates and analysis!