It has been said that economists have predicted “nine of the last five recessions,” or words to that effect, suggesting that the “dismal science” can’t be trusted. The whispers now about a looming crash come as nations engage in uncontrolled deficit spending, largely monetized by inflationary policies by central banks around the world, such as in Europe, China, and the US. In other words, the world’s solution to debt is… simply to create more debt. Today, global debt is more than three times the size of the global economy.
While that seems like a bad idea on the face of it, according to economic theory the cause-and-effect might work like this: inflating the money supply lowers interest rates, helping entrepreneurs (governments) find cheap money to make bets on new products (new infrastructure and new programs). But artificially low interest rates can also lead to systematic investment in areas of the economy where the standing economic fundamentals would otherwise not justify it. These “bad” bets at some point must be reconciled.
Curiously, amid all this monetary expansion, prices have failed to show much excitement. In the US, prices have increased by less than a 3 percent annual clip over the last ten years – low according to historical standards. Of course, that depends on how one measures it. Home prices have increased, in real terms, about 25 percent over the last ten years. During that time, real median household income has grown by 1.2 percent, meaning homes in the US have appreciated at twenty times income. The thing is, home prices – along with other assets like stocks, rare paintings and cars, and other collectibles – are not included in the consumer price index.
Nevertheless, high asset prices and low consumer good prices are consistent within a speculative bubble. During the 1920s, the US money supply grew by 63 percent over the decade, driving real estate and stock prices to historic highs. Yet consumer prices remained flat. The reason is that there were large productivity gains – falling information, telecommunication and transport costs, as well as increased specialization through global trade – leading to a natural deflationary trend in prices. The real manifestation of the inflation, then, was the difference between what price level ought to have been and what it came to be. Both real estate and stock markets crashed in 1929.
Today, where the US money supply has expanded by 85 percent over the last decade, the disconnect between asset prices and fundamentals is cueing us up for the same fate. Central banks are beginning to take notice, looking to unwind the inflation by gradually increasing interest rates. But this will come with a price: the bad bets, at first “papered” over by inflation, become apparent to all. The payment – a recession – is the process of liquidating these debts and diverting resources to more valued ends. When the Federal Reserve recently announced a rate increase to 2 percent, President Trump was more than a little concerned, saying: “the United States should not be penalized because we are doing so well. Tightening now hurts all that we have done.” Unsurprisingly, President Coolidge expressed those very same thoughts as monetary expansion began to unwind during his watch in the 1920s.
When the payment for all this easy money comes due is anybody’s guess. Maybe the sign will be Bitcoin collapsing or a Chinese stock market crash. Or maybe not. But the bill will come. How it will be paid also remains to be seen – will bad debts be liquidated or instead socialized forcibly onto the US taxpayer? And which taxpayer – those today or in future generations? In any case, based on how much debt has been created, the bill will be huge.
Rather than skewer failures of prognostication, it might be more apt to say that economists believe central banks have brought a punch bowl of cheap money to the party to keep the fun and the music going. When it stops and the party’s over driving home drunk will likely result in a crash.
Todd Gabel is a visiting assistant professor at the University of Texas at Arlington.
