38. When Dementia Replaces Meritocracy – Incompetence is Expensive
Last week the first crack appeared in the delusion of the financial markets and the Biden Administration. FedEx reported a sharp decline in their quarterly earnings and stated their opinion that the global economy is in a recession that began mid-June. Since they stated they daily transport 14% of the global product of goods, their perspective seems quite good.
It is interesting that June and July were when the global commodity markets suffered huge hits losing approximately 30 Trillion in asset value out of a reported $140 Trillion in total global asset value the end of May, 2022. I believe the two events are related, harbingers of the future.
Various financial analysts and market participants continue to express confidence that The Fed will pause raising interest rates in the first quarter of 2023. Their position is that we have seen the peak of inflation. One stated that he expected oil to stabilize around $80 per barrel next year and the cost of a new car to decline as the supply chain issues are resolved which by his calculation would reduce the annual rate of inflation to around 3%. Hence, in his opinion a 3.5% or 4.0% Federal Funds Rate is all that is needed to push inflation down to 2% by the end of 2023. What a nice dream.
Also last week it was reported that private individuals have approximately $4.9 Trillion in savings and corporations have $2.1 Trillion in cash. In my memory, that total of $7 Trillion in cash is close to the peak during The Great Recession. That is a great indication of fear or at least uncertainty in the market.
Many of the financial market analysts are trying to understand the current economy by looking back at the Stagflation in the late 1970’s. It is interesting to hear them discuss that period from a historical perspective as they did not live through it. I did.
Here is what they are not including in their calculations:
- Asset Value Destruction – Biden makes Jimmy Carter look good but both have created economic crises called Stagflation – a stagnate economy (recession) with high inflation. Like Carter, Biden does not understand Supply Side economics. President Reagan did. Therefore, The Fed has no choice but to raise interest rates rapidly until they are higher than inflation without waiting the one-year period between a change in interest rates and measuring the impact. That means The Fed will break things in the economy.
- Time – Carter destroyed the economy by 1978 and Reagan was elected in 1980 after campaigning on the Carter Misery Index (inflation plus unemployment). Inaugurated in January 1981, Reagan went to work on the economy, but it was late in 1981 before the tax laws were changed to increase the supply of goods (Supply Side Economics). The positive effects appeared in the American economy in late 1982, Four Long Years! The current crop of financial analysts thinks this fight with inflation will be over next year. Only if a new administration is elected in 2024 that understand Supply Side Economics will this misery be over in 2026. The pain has not yet begun.
- Capitulation – This occurs when the financial market participants realize that their rose-colored glasses have given them a false sense of security and all head for the exit. Last week one financial market analyst reported that the professionals have already reduced their exposure to the stock and bond markets and are siting with a lot of cash while the mom-and-pop individual investors have not yet moved. When they realize their mistake, there will be a financial market crash called “Capitulation”. Only on the other side of capitulation will assets be correctly priced and the economic healing start. Capitulation will be triggered by the reduction in earnings. The FedEx report was the opening shot.
With CPI at 8.1% and Core Inflation at 6.3%, The Fed needs to raise rates to at last 6.8% if not 8.6% to defeat inflation. I expect inflation to increase this fall due to rising food prices. Thus The Fed may have to increase the Federal Funds Rate to 10%.
Obviously, our government is under the control of a sad collection of mentally ill, misfit toys driven by fear their evil acts will become known. The delusion is Biblical in proportion. So where is reality and how does that reality impact the value of assets including land?
Some of the answer is found in Europe who a decade ago swallowed the Climate Change/
Green Energy pill and began to shift all of its electricity production to solar and wind. Today they know that neither is reliable, more like hobbies than serious energy production methods. As a result, this winter many Europeans will be sitting in the dark, hungry and cold, without jobs because electricity rationing closed the industrial companies along with retail shops. It will take a decade for Europe to correct their folly. Wake up America!
Part of the answer is found in China. Xi’s campaign to destroy capitalism in China is succeeding so the previously predicted collapse of China Evergrande and most of the Chinese real estate development industry is blooming while the Chinese economy implodes. Consistent with historical patterns of dictators in trouble using their armies to conquer neighbors China, Russia, and Iran just formed a “mutual defense” organization. Remember the Axis of World War II? Historically, weak American leaders and soft military invites aggression by the bad global actors.
To understand where the American economy is headed, please remember our past discussion in this blog that new home construction is an important leading economic indicator. This recession, not counting the Pandemic Recession, is the seventh in my career. At the peak of each of those residential cycles, home builders were in a panic thinking they had a shortage of lots. But once the bubble burst, they realized they had a surplus of lots. Same number of lots, but a plummeting absorption rate changed the equation. Nationally, homebuilders realize they have a surplus of lots and are trying to unload the extra. Currently the surplus problem is worse in the Midwest and western markets. In short, the new housing bubble has burst, Shortage is now Surplus. Uh Oh.
FedEx stated the global recession started June 15. Let us summarize – in the middle of a global recession, The Fed is fighting inflation by raising USA interest rates to reduce demand down to the current level of supply so prices will stabilize while the Biden is actively increasing the deficit spending hyping demand. This is similar to driving a car with one foot on the brake and the other on the gas pedal. Hence The Fed cannot lower interest rates to fight recession. Instead, The Fed will be raising interest rates at such a fast pace they will be guided by how much breaks in the economy. Does that sound to you like a “Soft Landing”?
Here are my current guesses as to what The Fed breaks:
- Hedge Funds – I look for a massive collapse in the hedge fund arena. Since they are not publicly traded, we must wait to find out the winners of the Hedge Fund Collapse Derby. The ripple effects will impact major banks loans to hedge funds. This unfolds in 2023 and will propel our economy into the depths of this recession.
- Sovereign Debt – The country of Sri Lanka could not handle its “Belt and Road” Chinese debt, so it collapsed. They win the “Sovereign Debt Collapse” derby. But there will others and those impacts will ripple globally which combined with the hedge funds could propel us into a depression.
- Asset Values – The most likely scenario is that inflation surges again this fall causing the Fed to continue to raise interest rates perhaps most of next year and as high as 10%. Coming off of an extended period of interest rates being zero, all financial assets and real estates are currently overvalued. As The Fed raises interest rates toward 10%, unemployment will soar, and the value of all financial assets and real estate assets will collapse.
The media talking heads plus the participants and financial analysts on Wall Street are still in a form of self-delusion, a denial of reality reminiscent of the Sanhedrin who refused to believe Jesus is the Son of God.
“Nicodemus said to him, “How can these things be?” Jesus answered him “Are you a teacher of Israel and yet you do not understand these things?”’
(John 3:9-10) New Revised Standard Version, Oxford University Press)
Here is what I know: God is real, Jesus was resurrected, the Holy Spirit is active, and God is in control, but He expects us to be his hands and voice.
Stay healthy,
Ned
September 21, 2022
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