Wondering about the stock market after yet another volatile week of the surreal? Below, we look at what will make the stock market turn nasty—and stay that way.
Does Debt Even Matter?
Short answer: Yes.
Fed Answer: No.
From David Hume to von Mises, informed (and honest) economists (i.e. those not afraid of controversy, truth or worrying about tenure or a Cabinet post) have all understood one basic truism: debt kills economies.
I’ve described the math, facts and history behind this simple truth in countless reports, but for simplicity sake, just click here for a basic preview of what it all means and how we can prove it.
The Big Question: Has the Fed Made Debt Worries Obsolete?
The seminal question today, and one that so many hope-hucksters and sell-side sucker-seekers pretend to answer is this: Does debt even matter anymore, so long as a central bank can print money to pay for it?
After all, there is technically no limit to how much money a central bank can print. Around the globe, central banks have already created $28 trillion in fiat currencies since 2000, so why not print another $28 trillion and keep the party going?
The absolute geniuses (I type that with a smirk) behind MMT (Modern Monetary Theory), for example, would have you and their election-seeking policy makers believe that such miraculous solutions (i.e. fantasies) are indeed possible, and without inflation.
Because in their opinion, if a central bank simply buys all the government debt handed out by Treasury Departments to pay for bailouts, national “Care” packages and wars, the money stays in a nice clean “balance sheet loop” and never leaks into the real economy or markets.
As such, we never have to worry about inflation again. The debt just sorta pays for itself, the money supply is locked behind a Fed dam, and hence: No worries.
Furthermore, if that money doesn’t “leak” out of the Fed/Treasury Monetized Debt loop, by their bullish (i.e. BS) logic, the money supply and the velocity behind it stays safely contained behind this nice and neat Fed & Treasury wall or dam, thereby allowing the US to print money to infinity and use that money to buy our own government debt (i.e. bonds).
By further logic, the MMT crowd calmly says that by having the Fed buy all of Uncle Sam’s IOU’s (i.e. Treasury bonds), the yield on those bonds stays permanently low (yields go down as bond prices/buyers/demand go artificially up), and by extension, interest rates go down with the declining yields.
And if interest rates are low, the cost of debt is low, so just keep on borrowing with impunity, right? Party on! Right?
And if the cost of debt is low, companies in the stock markets can just roll-over their debts every so often and never have to worry again about actually being profitable or caught in a credit crunch.
Again: Just borrow to infinity.
Seems pretty simple, right?
Too Good to be True?
But it also seems too good to be true, doesn’t it?
Think about it: Do you really think we can just print money to infinity and double our debt levels ever 10 years or so with no economic or market consequences?
This is like thinking one can drink 20 martini’s and never get a hangover—just a nice cool buzz.
So, what gives? How does the fantasy scenario being pitched to you above (i.e. debt without tears) actually fall apart, and with it, the reputations of all those morons peddling the MMT miracle?
Two Broken Fish Bowls: The Economy and The Stock Market
Well, to bluntly answer that question, we first need to look at the economy, and then we have to look at the markets, as they are two very different fish bowls.
The Economic Fish Bowl—Already Broken to Pieces
As for the economy, clever and blunt folks like Hume and von Mises remind us that once the ratio of debt to GDP gets past 90%, the economy loses 1/3 of its growth rate.
Pretty terrifying, no? Something to be avoided, no? Something our elite geniuses (again with the smirk) at the Fed would never allow to happen, no?
Well folks, the US debt to GDP ratio is now well past the 100% mark and last quarter’s horrific 33% tanking of the GDP confirms that what once seemed like a speculative nightmare possibility is in fact already a nightmare reality.
In short, our economy is already on its knees.
Just walk out the door, turn on the TV and look around you. The real economy is suffering and has been doing so long before the COVID hysteria ruined all the fun for 2020.
We’ve shown this for years, so no big surprise for informed investors.
The Stock Market Fish Bowl—Nervous Gold Fish
But what about that second fish bowl, the US stock markets? It’s immortal, no?
Can unlimited QE and Fed Yield-curve controls artificially keep the markets forever drunk in one big permanent party—a kind of nationalized exchange paid for by fiat dollars?
After all, since the Great Financial Crisis of 2008, every market dip has been saved and bought by an accommodative Fed, including the scare we got on Christmas Eve 2018 or the more recent smack the markets took in the COVID crash of Q1 2020.
In short, the Fed can basically prop up even the worst market scenario, right?
That’s a real pleasant thought. Seductive too. Makes you want to fall in love with the Fed, no?
But as I just recently wrote, it’s dangerous to fall in love with the wrong gal…And the Fed is no exception.
How the Fantasy Ends
Here’s where the fantasy ends, and how it plays out.
You see, that “perfect loop” we discussed above wherein all that printed money just stays behind a nice Fed dam (i.e. balance sheet fraud between the Fed and the Treasury) is in fact riddled with cracks, holes and weak spots.
Stated otherwise, there are “leaks” in that self-contained system. Money is slowly pouring into the real economy and the markets directly, which means the risk of inflation is returning rather than extinct.
Inflation, as we recently reminded, makes debt costs rise; and rising debt costs makes the debt rollovers which currently sustain the debt-soaked stock market tank rather than “recover.”
That means our market’s love affair with debt, which is fun (as all love affairs are in the opening chapters), is about to turn nasty. And so, by extension, the stock market is about to get nasty.
What Makes the Stock Market Turn Nasty?
The answer is simple. In fact, David Hume gave it to us almost 300 years ago.
You see, when economies and markets driven by debt have an “uh-oh moment” like the kind we saw in Q1, deflation kicks in as prices tank. This is a normal part of the deflation to inflation cycle.
And after deflation plays out, the inflation part slowly steps in. How?
Well, this happens when all that printed money hitherto kept nice and fraudulently contained between the Fed and the US Treasury starts to go outside of the Fed’s balance and instead leak directly into the markets, Main Street and the real economy.
When this happens, all that printed money gains something the fancy lads call “velocity,” and when velocity of money increases, well that’s a tail wind for something called inflation.
And remember: inflation means rising interest rates, and rising interest rates means rising debt costs, and rising debt costs is precisely what kills a debt-driven stock market.
In case you haven’t noticed, a lot of money is now leaving the Fed’s money printer and going directly into the stock market, as the Fed is now literally printing money to by US securities.
Furthermore, DC is sending COVID paychecks to millions of unemployed citizens to the tune of trillions. That’s real money heading into the real market and the real economy—one rocked by the woes of unemployment.
And that, folks, slowly evolves into the kind of inflation the Fed can’t control.
Until recently, the Fed Reserve Act of 1913 forbade the Fed from injecting money directly into the markets and economy. That is, the Fed was designed to loan, not spend.
Again, David Hume warned of such powers long before the Fed was immaculately created on Jekyll Island.
Thus, if you want to track the speed of how soon inflation will come, and thus how soon markets will implode, track the yield on the 10 Year Treasury Bond as well as the velocity of money, which is currently checking in at a “safe” 1.3 to 1.4 channel.
When, not if, inflation comes and rates rise, however, the fake party these markets have been enjoying since 2009 comes to a rude and abrupt end.
And guess what, that inflation leak/flow is starting to trickle in…
Instead of fun, love and martini’s, the only thing the S&P and inflation will offer investors is the hangover of a lifetime.
For now, however, with 10-year yields at .69% and the velocity of money hovering at 1.4, we are still in the deflation chapter, not the inflationary stage.
At Signals Matter, of course, we are tracking these and hundreds of other indicators to keep our subscribers safely in the green but with one eye always on the giant red flags blowing in the distance.
When the market turns nasty, your portfolio won’t.
Matt & Tom