The Austrian Theory of The Business Cycle

Don't Fight The Business Cycle

Not exactly an ideal recipe for major U.S. stock market gains going forward...

...especially given still rich valuations.

Related:

The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks

Chart of The Day: The Boom-Bust Cycle

The boom-bust cycle seems to be entering the bust phase. Little wonder U.S. stock prices are finally facing headwinds.

Chart of The Day: The Yield Curve & The Money Supply

Chart of The Day: Same OId, Same Old - Heading For The Bust, Again.

Related to this chart: The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks

This Time Was Never Different, It Was Just More Of The Same For Longer

The U.S. market (and many others) has been feeding on savings and thriving on confidence for a long time. The former is long gone, what happens when the latter vanishes will not be pretty - of which we perhaps received a warning today with the Dow down 4.60%.

Related: The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks

Chart of The Day: The Seeds Have Been Sown For The Next Bust

Sky-High "Systemic Risk"

Rising stock market prices over time has little to do with economic growth as they are largely a reflection of monetary inflation. Though increased economic growth facilitates increases in the money supply, monetary inflation actually results in growth that lags potential. Furthermore, monetary inflation sets in motion the business cycle with an inflationary boom followed by a very real correction. Monetary inflation is therefore, more than anything else, a source of risk in an economy. 

Increased saving (the act of earning more than is spent) on the other hand is a source of financial stability. Decreased saving is the opposite, though it admittedly creates the illusion that the economy is expanding due to an ill-placed obsession with GDP (of which consumers spending makes up around 70% in the U.S.). 

Combining the two, it should be clear that stock prices outrunning saving on a vast scale and over a longer period of time necessarily brings with it the potential for great economic instability sometime in the future. With the ratio between the two spiking to a new record high in recent months, that time is fast approaching. 

As of January 2018

It's a safe bet that economic measures like this one are not included in central planners flawed econometric models of "systemic risk". Which is a major reason they always fail to predict (and stop them before it's too late) major market turns and GDP recessions. Just as they will this time around as well. Needless to add, if they were aware of the economic problems caused by monetary inflation, they would not have allowed it to happen in the first place.

Related: The Money Cycle, Stock Market, And The Return Of The Inflation Premium

Stock Market Euphoria Alert - The CAPE to Saving Rate Ratio Surges 6.2% In A Month

One month ago today I pointed out the growing gap between the S&P 500 CAPE and the personal saving rate in the U.S. (see The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks), a ratio which helped identify the two previous stock market bubbles. At the time the ratio clocked in at 9.33. Today it comes in at 9.91, a 6.2% increase in just one month, and quickly closing in on the record set during the highs of the dotcom bubble. 

Since Trump got elected, the ratio has nearly doubled thanks to a highly toxic combination of a slowing rate of saving (down 35.1%) and a spiking P/E multiple (up 20.6%). 

The above ratio is based on the 12-months average saving rate. If we compare the CAPE with the monthly saving rate however, the ratio now even surpasses the dotcom highs, with quite a margin.

As I explained in the article linked above, the euphoric heights of this ratio indicate troubles ahead for both the U.S. stock market and the economy in 2018, troubles which will spill over to other economies around the globe as well. And do keep in mind that debt levels are substantially higher this time around, especially federal debt. Something simply has to give at this stage, sooner or later. 

It Is For You To Tell Me How This Can End Well, Not For Me To Tell You Why It Will Not

Broad-based financial bubbles are created by an expanding rate of monetary inflation whether expected or not. The more aggressive the expansion and the longer it lasts, the bigger the bubble, especially when CPI inflation remains "subdued" and "well-anchored".

As of December 2017

Add a near decade-long ZIRP on top and you've got an excellent recipe for an equity bubble of epic proportions - like we currently have in the U.S. and in many other stock markets around the world. For more on this, see 11 Charts Exposing The Madness Of The Stock Market Crowd and The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks.

Related: The Austrian Theory Of The Business Cycle - A Short Synthesis

Chart of The Day: Central Bankers' Boom Bust Cycle

Asset Prices Are Prices Too

By Thorsten Polleit

We live in inflationary times. Some people might consider this statement controversial. This is because these days inflation is widely understood as a rise in the consumer price index (CPI) of more than 2 percent per year. However, there are convincing reasons to question this viewpoint. On the one hand, the CPI does not include “assets” such as, for instance, stocks, housing, real estate, etc. As a result, the price developments of these goods are not accounted for by the changes in the CPI.

On the other hand, and even more essential, price changes of goods and services are associated with changes in the quantity of money. This is why economists used to understand a rise in the quantity of money as inflationary (and a decline in the quantity of money as deflationary): Without money sloshing around, there could not be a phenomenon like inflation — that is an ongoing upward trend in all prices of goods and services over time. The truth is that rising prices across the board is inextricably linked to money.

One indicator of an inflationary monetary development is the link between the US money stock M2 and nominal GDP. This ratio can be referred to as a measure of "excess liquidity." Since the outbreak of the crisis 2008/2009, excess liquidity has been growing strongly — as GDP growth lagged behind the increase in the quantity of money. Why? Well, a great deal of the monetary expansion has been driving asset prices upwards — most notably in the stock and housing market.

Continue reading here.

Price Inflation Is Not The Worst Part Of Easy Money Policy

By C.Jay Engel

There are many critics of the Fed's recent money supply expansion, especially since 2008, whose chief criticism is that it will result in consumer price inflation. While proponents of the Austrian School agree that high consumer price inflation is one possible result of an expansionary monetary policy, we neither hold it as necessary nor as the worst consequence of money creation.

For the Austrian, who defines inflation as an expansion of the money supply, rising consumer prices only take place to the extent that this new money drives demand for more consumer goods. But as Mises pointed out, new money does not enter the economy neutrally; that is, it enters in specific ways and in accordance with specific mechanisms. This affects where the rising prices will show up first. And if it takes decades for the newly created money to reach consumers, then it will take decades for the consumer prices to rise.

Secondly, rising consumer prices are by no means the primary evil of monetary expansion. The primary evil of monetary expansion under our money and banking system is the harm done to the capital structure. The artificial suppression of interest rates that results from the expansion of the money supply has an eroding effect on the economy's capital stock. When interest rates are suppressed below what they would have been without the monetary expansion, investments in unprofitable projects suddenly appear to be profitable. This is the basis for the Austrian Theory of the Business Cycle. Capital is allocated to projects that the economy cannot in actuality support, and is therefore squandered.

When critics forget that (a) rising consumer prices are not a necessary result (also see Murray Rothbard's America's Great Depression, page 85-87) or (b) that consumer price increases aren't the primary evil of monetary expansion, they don't have much to say in response to mainstream economic narrative of our time: The Fed has quadrupled its balance sheet, so where's the inflation? If anything, the Fed is going to need to do more to create inflation, considering we have entered a dangerous era of "lowflation."

Before a comment is made on what happened to the inflation, let's remind ourselves that the Misesian understanding of the business cycle presupposes that the new money makes its way to the economy via the credit markets. That is, all else being equal, there would be no business cycle if the money was just printed by the government and handed out equally to consumers. The business cycle takes place because the new money is loaned out by banks to businesses which use this money to invest in longer processes of production. The investment with the new money into the capital structure first bids up the prices of the "factors of production."

Continue reading the article here.

A Plummeting Money Supply Impulse And Surging Volatility Are No Friends Of Financial Stability

Related:

Economic Issues Unfold As The Money Supply High Tide Ebbs And Becomes Low Tide

The Money Supply Bear Market Continues, Growth Rate Plunges Below 3% Mark

Following nine years of aggressive monetary expansion in the U.S., the money supply growth rate has now dropped back to Lehman lows. 

The sharp fall in the growth rate during the last year has pushed the money supply impulse down dramatically and close to a 26 year low. 

As stocks thrive on an expanding money supply growth rate and loath a falling one, it's only a matter of time before the next U.S. bear market sets in. 

As of 27 October 2017

Related: 

Gold As A Safe Haven Asset Now Primed To Excel

Chart of The Day: In Gold We Trust 2017 chartbook - The M2 Money Supply to saving Ratio

I'm very pleased to see my money supply to saving ratio chart included in the In Gold We Trust 2017 chartbook. 

To view the other 59 charts included in the chartbook, click here to download it for free!  It is a must-read for prudent investors and money managers, and for serious students of finance and economics.

You can access the compact version of the In Gold We Trust 2017 report here for analysis and insights. It is a report I highly recommend you read every year when it's published.

Troubles Looming As The U.S. Bank Credit Impulse Hits Pre-Lehman Brothers Low

For why the credit impulse is of great economic importance, see:

The Banking Crisis - Why It Will Happen Again

More Serious Than Stock Market Participants Appear To Believe

Related:

The Money Cycle, Stock Market, And The Return Of The Inflation Premium - This Chart Is Off The Scale

The Money Relation - Still The Calm Before The Storm

For full analysis of the money relation reading for August 2017, see:

The Money Relation - Yet To Signal An Economic Reaction, But...

Highly Unusual Developments in the U.S. Money Supply

The numbers for the final week of August have just been released and they show a highly unusual development for being this late in the year: the money supply is actually lower today than at the beginning of the year. 

If this continues it will not be long until the year on year growth rate turns negative. More specifically, if the current trend continues the growth rate could plummet below zero - a development which has not taken place for more than 22 years - sometime in October, if not earlier. Even if it does not, the growth rate will nonetheless fall sharply in October compared to last year when it hit more than 12%.

Though there are leads and lags between changes in the money supply growth rate and stock market returns, October may look like a particularly dangerous month this year as the money supply growth rate has slowed more or less continuously and at great pace all year. Sooner or later money will become scarcer (and interest rates higher) and favoured over stocks forcing a stock market sell-off and a potential panic.

Also, the price deflationary pressures that will kick in may lead the Federal Reserve to abandon all talk of further potential interest hikes. In fact, it may have no other choice (given the misplaced "theories it operates under) than to implement the next round of QE (though it will be too late to avoid a stock market panic).

In other words, this is not the time to be long the U.S. stock market and other stock markets that correlate with it.

Related:

Ahoy! The U.S. Stock Market On Course To Crash