On Tuesday, an astonishing milestone was reached as the Dow Jones Industrial Average closed above 15,000 for the very first time. It is a remarkable moment in our era, evoking a sense of wonder and excitement.
In contrast to a century ago, when innovations included flying machines and indoor plumbing, today’s milestones are defined by advancements such as iPads and the Dow reaching 15,000. While iPads are undeniably impressive, the significance of reaching Dow 15,000 raises more unsettling questions.
It is evident that extensive government intervention in price setting has obscured the distinction between genuine economic growth and a mere illusion of it. At times, differentiating between the two can be exceedingly challenging. However, specific instances crystalize the differences when misallocation of capital escalates to extreme levels.
Take the dot-com bubble in the late 1990s and the housing bubble in the mid-2000s as examples. Initially, they appeared to signify authentic economic prosperity, only to later reveal themselves as mere illusions—harmful byproducts of monetary policy.
For several years, it has been increasingly apparent that a Treasury bond bubble is developing. While the exact timing of its burst is unknown, holding Treasuries now resembles clutching a lit stick of dynamite—you’d be wiser to discard it before risking severe losses.
Banks are Starting to Lend Again
Similarly, the milestone of Dow 15,000 has clarified the recent stock market surge. Before this achievement, it was ambiguous whether the rise was solely driven by Federal Reserve actions or supported by the groundwork of a new economic boom.
Now, with the achievement of this landmark, it is evident that we are entering another one of the great boom-and-bust cycles of our time. This cycle could inflate much more than any prudent observer would anticipate. While we may not relish this reality, we are determined to navigate it with purpose.
The economy now appears to be operating on a fragile debt-laden foundation, sustained by an inexhaustible flow of paper currency. Despite this, it remains unclear whether the economy is strengthening or weakening; some economic indicators are on the rise, while others falter.
Amidst this uncertainty, troubling news arrives as indicated by the latest Fed Senior Loan Officer survey—banks are beginning to lend again. If true, and we have no reason to doubt it, life as we’ve known it since the financial crisis of 2008 is on the brink of transformation. Here’s why…
Since late 2008, the Federal Reserve has dramatically increased its monetary base from $900 billion to $3.3 trillion. However, this newly created money has largely failed to permeate the economy. This is attributed to pervasive fear, stricter lending standards, and banks needing to mend their balance sheets post-housing market collapse.
Coming Uncorked
These factors have caused a malfunction in the conduit for the Fed’s monetary policies. Instead of flooding the economy with cash, the excess funds languished on bank balance sheets or were used to invest in Treasuries. In central banking terms, this phenomenon is described as “pushing on a string.”
The Federal Reserve tries to stimulate the economy by expanding the money supply; however, the intended effect—money circulating within the economy—has been stymied. This is why, despite rampant money creation, inflation has yet to materialize.
“In the latter half of last year, the major U.S. banks finally completed their cycle of repairing balance sheets after the financial crisis,” said Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, in a recent client report. “Now, they are focusing on utilizing their balance sheets.”
This indicates that the engine for credit flow is finally restarting, allowing money to re-enter the economy for the first time since mid-2008. As a result, inflation is on the verge of becoming a reality.
Once banks resume a robust lending strategy, several latent repercussions of the Fed’s easy money policies will swiftly come to the forefront. Given the money multiplier effect and the “magic” of fractional reserve banking, a mere $1 trillion increase in the Fed’s balance sheet could potentially yield $5 trillion—if not more—in economic circulation.
Unfortunately, the consequences will extend beyond just inflating stock prices; prices across the board will likely rise. At that point, the Fed will have to rethink its approach and begin withdrawing the easy money supporting the stock market. When that shift occurs, brace for impact.
Sincerely,
MN Gordon
for Economic Prism
