Toro
Diamond Member
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- #421
I may have written this earlier but I am going to post this here.
We live in an asset-driven economy.
The typical economic cycle during the post-WWII period followed a certain playbook. When demand started to accelerate and capacity tightened, inflation would rise, as there is a response-lag between accelerating demand and additions to supply capacity. In response to accelerating inflation, the Fed would increase interest rates, causing a decrease in demand for credit and thus for goods. Because supply growth lags demand, supply would build as demand was decelerating. Inventories would build up as demand slowed, and companies would cut back production, laying off workers. Economic activity would contract and the economy would enter a recession. In response, the Fed would cut interest rates, and the cost of credit would fall, making it cheaper for companies to finance capital projects. Excess inventories would be cleared away, economic growth would resume, and laid off employees would be called back to work. This is the inventory/credit cycle, and it best represented the dynamics of the economy from 1945 through 1998 (though some might say it ended in 1987, not 1998).
The inventory/credit cycle is still in force today, of course. However, since 1998 (or 1987), the asset-driven economy has become far more important.
In 1998, the Federal Reserve organized the rescue of Long-Term Capital Management, a highly-leveraged hedge fund that speculated primarily in fixed income products. In addition, the Fed cut interest rates three times in six weeks, igniting the final stages of the Tech Bubble. The Nasdaq went up 87% from the bottom on October 8, 1998 to the near-term top on February 1, 1999. The Naz consolidated into the summer before doubling into March 2000, signaling the top of the Tech Bubble.
I mark 1998 as the end of the post-war period, but one could also mark October 1987 when Greenspan slashed interest rates in response to the stock market crash. That was the beginning of the Greenspan Put, whereby the Federal Reserve would bail out asset markets when they were under extreme duress. However, 1998 marked the beginning of the systemic excesses of the asset-driven economy, beginning with the Tech Bubble. For the past 12 years, unlike any time in history, the Federal Reserve has been targeting and responding to rolling asset bubbles, of which it is a prime culprit for creating. This is the era of the asset-driven economy.
Not just the Fed, mind you. Though there was no fiscal response to the collapse of LTCM, the 2001-02 fiscal response by the government and the monetary response by Federal Reserve to counter-act the asset-driven recession caused by the collapse of the Tech Bubble was the biggest stimulus ever up to that time.
As we all know, the Tech Bubble begat the Housing Bubble. Cheap money fueled an orgy of real estate speculation unlike anything seen before, easily surpassing the Tech Bubble, with far more widespread affects to the economy.
Unsurprisingly to anyone with an understanding of valuation and history, the Housing Bubble collapsed. In response to the even bigger economic fallout of the even bigger collapse of the even bigger housing bubble, the government responded with an even bigger stimulus package. Jim Grant of Grants Interest Rate Observer estimates that the current stimulus is 10x larger than the average stimulus relative to GDP since WWII, dwarfing the stimulus following Tech Bubble collapse, which Grant estimates was 4x bigger than the post-war average.
The typical economic cycle during the post-WWII period followed a certain playbook. When demand started to accelerate and capacity tightened, inflation would rise, as there is a response-lag between accelerating demand and additions to supply capacity. In response to accelerating inflation, the Fed would increase interest rates, causing a decrease in demand for credit and thus for goods. Because supply growth lags demand, supply would build as demand was decelerating. Inventories would build up as demand slowed, and companies would cut back production, laying off workers. Economic activity would contract and the economy would enter a recession. In response, the Fed would cut interest rates, and the cost of credit would fall, making it cheaper for companies to finance capital projects. Excess inventories would be cleared away, economic growth would resume, and laid off employees would be called back to work. This is the inventory/credit cycle, and it best represented the dynamics of the economy from 1945 through 1998 (though some might say it ended in 1987, not 1998).
The inventory/credit cycle is still in force today, of course. However, since 1998 (or 1987), the asset-driven economy has become far more important.
In 1998, the Federal Reserve organized the rescue of Long-Term Capital Management, a highly-leveraged hedge fund that speculated primarily in fixed income products. In addition, the Fed cut interest rates three times in six weeks, igniting the final stages of the Tech Bubble. The Nasdaq went up 87% from the bottom on October 8, 1998 to the near-term top on February 1, 1999. The Naz consolidated into the summer before doubling into March 2000, signaling the top of the Tech Bubble.
I mark 1998 as the end of the post-war period, but one could also mark October 1987 when Greenspan slashed interest rates in response to the stock market crash. That was the beginning of the Greenspan Put, whereby the Federal Reserve would bail out asset markets when they were under extreme duress. However, 1998 marked the beginning of the systemic excesses of the asset-driven economy, beginning with the Tech Bubble. For the past 12 years, unlike any time in history, the Federal Reserve has been targeting and responding to rolling asset bubbles, of which it is a prime culprit for creating. This is the era of the asset-driven economy.
Not just the Fed, mind you. Though there was no fiscal response to the collapse of LTCM, the 2001-02 fiscal response by the government and the monetary response by Federal Reserve to counter-act the asset-driven recession caused by the collapse of the Tech Bubble was the biggest stimulus ever up to that time.
As we all know, the Tech Bubble begat the Housing Bubble. Cheap money fueled an orgy of real estate speculation unlike anything seen before, easily surpassing the Tech Bubble, with far more widespread affects to the economy.
Unsurprisingly to anyone with an understanding of valuation and history, the Housing Bubble collapsed. In response to the even bigger economic fallout of the even bigger collapse of the even bigger housing bubble, the government responded with an even bigger stimulus package. Jim Grant of Grants Interest Rate Observer estimates that the current stimulus is 10x larger than the average stimulus relative to GDP since WWII, dwarfing the stimulus following Tech Bubble collapse, which Grant estimates was 4x bigger than the post-war average.
