January 24, 2016
The End of a Bubble, Version 2016
World financial and commodity markets are now poised for a fourth week of spasmodic turbulence. In constant dollar terms oil is nearly as cheap as it has ever been, while China faces the slowest economic growth of modern times. Here in the US, December retail sales growth was actually negative, marking an awful season. Then, stocks waited until the first trading day in January to plummet, fueling fury about stock manipulation in every conspiracy theorist and Bernie Sanders supporter.
On the face of it, this has many of the hallmarks of a recession. And it may be, but what if instead of a recession, what we see now are markets of all types returning to where they are supposed to be? That is the interesting question.
American labor markets are fairly strong in the limited sense that those who wish to work can find a job. Still, job growth and the productivity of American workers has been sufficiently slow to keep growth of the overall economy very modest. While the American economy is a bright spot in the world, our real economic growth is far too weak to support the rapid stock market gains of the past few years.
The doubling of the major American stock indices since 2009 would imply rapid and optimistic GDP growth. That has not been the experience of the U.S. economy. Thus the best value measures of our stocks suggest they remain heavily overvalued, even after the past few weeks. This suggests that the current stock market declines reflect a movement to reality, not recession.
The crash of commodities, including oil is mostly natural. A slowing economy needs fewer precious metals, steel and petroleum. But, not all these commodities are driven wholly by markets. Saudi Arabia and several other OPEC countries face an existential threat from Iran. OPEC’s continued interest in low oil prices is not about weakening American shale production, which is a minor profitability nuisance. It is all about crashing the Iranian economy and weakening its influence.
China’s economy faces a permanent slowing. Almost all growth in China over the past half century has come from moving peasants from subsistence farms to late 19th century factories. The country is running out of peasants, slowing even its unreliable official growth numbers. China remains a Marxist-Leninist nation, with poor economic prospects. Chinese citizens will be lucky to have the 2000 American standard of living in 2100, even if they peacefully abandon communism.
So what about the current economy? We should expect US equities to drop and commodities to remain low. This will continue to evaporate wealth, which will in turn slow major sectors of the economy such as retail sales, auto production and home construction. This is the unavoidable deflation of a bubble. The silver lining on appropriately priced stocks and much lower GDP growth may be that the US can once again pay attention to fundamentals; education, distortionary taxes and federal programs that disincentivize labor and investment. That is the economic debate of 2016.
About the Author
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