Q&A Answers – 3/21/2020
Since we were unable to do Liberty Talk Radio again, I’m going to address the questions we received here. The chart below will be a point of reference for most of them.
The chart above shows the Dow Jones Industrial Average from approximately 1905. You’ll have to click to see the chart in detail and I apologize for that – it is hard to get a decent chart with that kind of timeline.
The first ‘peak’ if you can even call it that was the roaring 20s and the bursting of the speculative bubble in late 1929. The Dow would lose more than 75% of its value before the move ended.
The next events are pointed to as well. The main question people have is ‘How was the DJIA near 30,000 to begin with?’ It’s a good question. There are a couple of reasons. First is inflation (growth of the money supply). More money chasing after a relatively fixed set of goods produces higher prices, all else being equal. Let’s proceed through the timeline to get to an answer about Dow 30,000.
Inflation and the revocation of the Glass-Steagall Act allowed for the run-up and eventual blowup of the dot-com bubble. The fact that many of the dot -com firms never made a single penny in profits yet sold for hundreds of dollars a share contributed as well. We’d call this part a speculative bubble. Inflation put the money in the system to allow the bubble to reach the level it did.
After the 2002-03 recovery, the central banks (globally) began serious interference in markets, causing distortions and artificially low interest rates (aka cost of capital) that allowed the next bubble – the housing bubble to inflate. Again, more money in the system due to inflation and a lower cost to that money thanks to the central banks and voila! Boom.
If you thought that was dramatic, the federal reserve in the US and other central banks began something known as ‘quantitative easing’ or QE. This is a fancy term for printing money from thin air and injecting it into the financial system and economy. In the business we call it ‘hot money’ because it’s like a hot potato. It moves around very quickly. From 2009-2019, we had multiple opportunities for what is happening right now and each time, the central banks intervened with more hot money and you can see by the shape of the curve after 2009 how the slope increases dramatically.
This general shape of curve is consistent with monetary systems that are built on fractional reserve banking and that feature a unit of currency that isn’t backed by anything tangible. Until 1971, the USDollar was at least partially backed by gold. I didn’t mark the area, but if you look on the chart at where the curve really starts to accelerate upwards, that was right in the 1971 time frame.
There has been some speculation about fractional reserve monetary systems of late. The important thing to note is that this particular type of system allows for inflation (the creation of new money) when debt is incurred. A quick example is in order. I take 100 depreciated American dollars to the bank and deposit it. Joe Cristiano comes along and asks my bank for a loan, they will lend him up to around $90 of my deposit. However, the bank still owes me my $100 initial deposit. At this point, the money supply went from $100 to $190.
One of the often used misconceptions is that, therefore, when loans are repaid, that equals deflation (the destruction of money). It does not. Let’s use our above example. Joe repays his loan to the bank after 30 days. Let’s say they were very charitable and say they charged him 1% total interest for the 30-day loan. So, he would repay $90.90. Now, my initial $100 is still in there so the total is now $190.90. No deflation.
However, when people pay down loans instead of taking out more debt it does dramatically slow the rate of bank-created inflation. This happened during 2010. Governments don’t like this because they’ve invested a great deal of time convincing people that inflation is necessary for growth to occur. If the people won’t borrow, you can sure bet the governments will do it for them and that is exactly what took place in 2010.
A final thought. A few asked if what is going on would have happened if we didn’t have a global biologic event. As you can see by the chart above, we’ve been long overdue. The QE done by the federal reserve is unhealthy for the economy and if our economy was truly healthy, it wouldn’t need constant stimulus or massive federal, state, local, and personal deficits to function. The ‘solution’ for nearly 2 decades has been to print money and blow up bubbles. Put simply, at some point bubbles always burst and this most recent one was looking for its pin.
Sutton, Mehl – 3/21/2020
