Going past what is sustainable… Another market failure

There are quite a few shifts happening in the global and domestic economy. I have been observing for the past week. So many people are getting confused. Here is a list of concerns…

  1. China is slowing down.
  2. Some emerging markets are facing capital outflows and are tempted to raise their central bank interest rates. Argentina is all over the news now, but we saw in early December here on Angry Bear that there was trouble brewing.
  3. Inflation exists in emerging markets leading to more temptation to raise CB interest rates.
  4. US stocks have sent a psychological message that their is serious concern for further advancement in the economy. I say serious because the “correction” of last week was more than a correction. Barry Ritholtz called it a 90/90 day, when more than 90% of the volume and 90% of the stocks are down.
  5. There are calls for more easing by the Fed. Case in point is this article by David Llewellyn-Smith called Will China stop Taper? There is concern that the economic momentum of the last couple quarters will not continue.
  6. On the other hand, there is pressure building in the US to raise the Fed rate as signs of economic growth appear. But inflation remains muted as rumors spread of its rise.

This is a character defining moment in capitalism, when the majority are not aware that the end of a business cycle is forming. There is asymmetric information, if you will. A few understand it. The majority do not. So what should be a time of seeking a sustainable level of output to establish a stable base for future growth to benefit society, will turn out to be an increasingly unstable game of seeking non-existent profits and protecting self-interests.

Some may simply point to inefficient investments in China as bringing down the economy. Yet China is up against our own effective demand limit, because they rely heavily on our consumption. They saw the writing on the wall. They saw persistently limited demand in the US. They knew they had to start raising wages there. and they have been doing that. But it won’t be enough to keep their over-production from slowing down. Their household consumption as a percentage of GDP is still decreasing.

The low Fed interest rate has been an illusion tempting people to take advantage of all the spare capacity out there. Yet, the spare capacity itself is constrained considering weak effective demand. So people are led like cattle beyond what should be sustainable. The Fed’s forward guidance is producing false delusions of what the economy is capable of in a sustainable way.

Economists seem to live in a world believing that their ideas are complete. Although some have recently mentioned that a revolution in economic thought must happen. It is true. This time IS different. An unnoticed factor in the past is making an appearance… Effective Demand. A poorly understood concept from Keynes. Effective demand is well below full employment for the first time in a long time. The result is that we blindly keep walking past a sustainable state that has higher marginal social benefits than where we are headed.