A Did Not Cause B

A = coronavirus. B = economic meltdown.

A caused B.

That’s the mainstream narrative when it comes to the economic pain we’re feeling right now.

But in reality, A did not cause B. B was in the works long before A came along.

Of course, the mainstream never recognized the rot in the economy a few months ago. In fact, everything thing looked glowing on the surface. As economist Mark Thornton reminds us in an article published on the Mises Wire, on February 10, a mere 10 weeks ago, stock markets were at all-time highs. The unemployment rate was at an all-time low.

With interest rates near zero for an entire decade, the value of stocks, bonds, real estate, land, and virtually any asset was artificially inflated. As a result, total household net worth doubled, increasing from $60 trillion to $120 trillion!

People were saying that things were too good to be true. Everything from giggling about personal finances at the gym to people embarking on unlikely business projects, and business owners being shocked when told it would not last, and even record-breaking skyscrapers. Things were too good to be true.

According to the mainstream narrative, things were roaring right along until this pandemic hit. Governments shut down a strong economy to deal with COVID-19. Since the economic damage due to the COVID-19 shutdowns was self-inflicted, it’s not a real recession. It’s not a real economic collapse. And since governments shut things down, they can make a few pronouncements and fire things right back up.

That would be plausible if A caused B.

But as Thornton reiterates, A did not cause B.

The coronavirus did not cause B, the economic crisis; it merely triggered it, causing it to occur earlier than it would have. It may have also accelerated the collapse, and will likely deepen the trough of the crisis in business cycle terms. In other words, the economy was weak, not strong. The fundamentals were weak, not strong. Balance sheets were weak, not strong.

Peter Schiff has been saying the same thing in a different way. Coronavirus was merely the pin that popped the economic bubble. Getting rid of the pin doesn’t stop the air from coming out of the bubble. And yet everybody is still focused on the pin.

Ths signs of a bubble were there months ago if people knew where to look. President Trump signaled that there was a problem when he badgered Federal Reserve Chairman Jerome Powell as the central bank raised interest rates a mere 2%. Thornton said this was a clear sign of weakness.

The stock market thrived when interest rates were negative when adjusted for price inflation. However, when Powell pushed the inflation-adjusted rate to near zero, stock markets stalled and all political hell broke loose.”

In response, the Fed abandoned balance sheet reduction and cut rates three times in 2019. That’s not a sign of a healthy economy. In fact, Schiff said the bubble was already leaking air before the coronavirus pin popped it completely.

It’s not like the Fed was able to keep shrinking the balance sheet and keep raising interest rates and it had to abort that process because of the coronavirus. They had to abort the process before anybody heard of the coronavirus. So, it was already imploding. The bubble was already deflating before this pin, this other pin came and put another hole in it. So, if we couldn’t unwind the four-and-a-half trillion-dollar balance sheet, if we couldn’t normalize the debt levels that existed before the coronavirus, think about how much more difficult, if not completely impossible that process is going to be after the coronavirus. So, nobody is asking: what is the implication of a balance sheet that is so enormous that it would be so disruptive to shrink, or because it’s so enormous and can’t be shrunk? What does that mean about future inflation and the value of the dollar?”

And therein lies the rub. Since A didn’t cause B, solving A doesn’t necessarily solve B.

Thornton points out that the artificially low interest rate environment created by the Fed allowed consumers and businesses to pile up excessive debt. It also disincentivized saving.

There was certainly an effort to increase savings after the housing bubble crisis. The personal savings rate, which had fallen to 2 percent before the previous crisis (the housing bubble), had now risen to 7 percent but was still well below the 10+ percent that was normal when we on the gold standard.

The main villains behind a depressed savings rate are inflation and taxation on interest income. One-third of American households have zero savings and 60 percent have less than $1000. In effect, the Fed and the Treasury have needlessly put millions of households at risk.

Consumer debt is now more than double the amount prior to the last crisis, student loans are now more than $1.6 trillion, and the combined consumer credit of households and nonprofits is over $4 trillion. And, of course, this debt is not evenly distributed across the population, as some people have enormous debts relative to their ability to pay and some have none.

And despite the low unemployment rate, the labor market also had cracks in it.

There were millions of jobs that were going unfilled and millions of college graduates who could not get jobs in their desired fields, but who were instead working as waiters and bartenders and living at home. One of the biggest villains here is student loans, which encourage too many teens into college and put them on unproductive career paths.

The other big factor distorting the labor market is the Fed and its monetary policy. The unpreceded decade-long zero interest rate policy has caused a massive business cycle. Here, by artificially causing malinvestments, the Fed changed what types of jobs are in high demand and distorted income distribution as well.

In general, the Fed’s interest policy has increased the demand for very highly skilled workers such as electrical engineers, biochemists, and patent attorneys with graduate degrees. The increased demand for these types of labor has increased wages and distorted the distribution of incomes.

These types of workers are necessary to produce such things as new iPhones, software platforms, computer chips, and pharmaceuticals, all of which require a significant amount of work by patent attorneys.

Another way to view the distortions in the labor market is to take note of the number of job openings. In December 2019 the number of openings was 7.3 million, the highest number since it began to be counted in 2000. One of the reasons I suspected an economic crisis was around the corner was that this number stopped climbing and began to fall noticeably, before it recently plummeted.

Meanwhile, the unemployment rate for recent college graduates had been 41 percent and about one-third of all college graduates are underemployed, meaning that their job does not require a college degree. Remember, total student loan debt has skyrocketed to $1.6 trillion. These are all signs of a badly distorted labor market.

Corporate debt was also at record levels before the pandemic. The issue wasn’t just the borrowing. As Thornton points out, the deeper problem was what these companies were doing with the borrowed money.  They were levering up for stock buybacks instead of capital investment to increase productivity. There was also a wave of mergers and acquisitions.

Apparently, the Fed’s zero interest rate policy has driven the marginal return of capital so close to zero that corporations have resorted to these types of financial manipulations in an attempt to increase profits.

Consumer debt and corporate debt, not to mention government debt that was already growing at recession-like levels before coronavirus created massive distortions in the economy. It wasn’t “great.” It was a great big, fat, ugly bubble riddled with malinvestments just waiting for a pin.

Coronavirus was the pin.

Thornton sums things up nicely.

Despite stellar numbers in the stock market and an all-time low unemployment rate, the US economy was already headed for an economic crisis. Prior to this economic crisis, we could clearly see that many consumers could barely pay their bills and had virtually no savings to rely on. The labor market was also badly distorted, with highly skilled markets booming, a record number of job openings, and massive numbers of recent college students unemployed or underemployed. Finally, the corporate market was also distorted, with firms using atypical financial manipulations such as share buybacks and mergers to increase profits. The viral pandemic merely triggered or revealed what was ultimately going to happen.