Contributed by Stephan Davied
The world seems to be in the throngs of something very strange. Are we in a recession or are we in a depression or are we in a 10 year period of just super low growth? The world has never coined a term to describe years and years of low growth, probably because it does not happen much.
Generally countries, businesses, schools and even humans go through cycles. The human normally sleeps at night and is awake during the day. This cycle is critical to our survival as we need the proper amount of down time to support our up time. Businesses go through cycles. Retailers are super busy during the holiday season and other times they are less busy. This is a retailers yearly cycle. Bigger than that are economic cycles. During times of robust business activity business struggle to keep up with demand so in turn they invest For example in times of robust growth a concrete company who can’t meet the demand of its customers might build another concrete plant.
The concrete company looks at its demands and forecasts for the following years and determines they need more capacity so they build another plant. This in turn puts more people to work which causes more demand and in turn the need for another concrete plant. As business cycles go up they also go down. During the boom periods of growth companies overbuild for the future and when the future isn’t so rosy we end up with downturns in the cycle. During the downturns the less efficient pieces of our business world are scuttled or shut down. In our concrete example the less efficient concrete plants won’t be able to compete with the new ones that were built during the last boom so these less efficient plants shut down. Business cycles are necessary to remove the waste in the system.
Imagine for a moment I end up with the stomach flu. My body go through a cycle to clean out everything inside. Basically during my ill cycle it flushes everything out to bring me back to optimal health. This flushing is necessary to restore my health.
And…. Along comes Central Bankers. Central Bankers are smarter than us “normal” people. Central Bankers don’t like big downturns. They protect us from “depressions” and “illiquid” markets.
This all sounds great, but any tampering with the “market” has a side effect. When Marty McFly went back in time, anything he changed in the past caused a huge reaction in the future. The same goes with the central bankers. Anything they tweak to make things better is going to have a side effect. Let’s go back to my example where I have the stomach bug. I determine that this type of stomach bug is very very dangerous. It could have me sick for weeks.
I go to the doctor “central planner” and he tells me that he has some medication that will remove the worst parts of my sickness. Based on their “theories” it should eliminate the “elimination” phase of my bug. But…There are side effects. They tell me that the only medicine that will help is estrogen and it may have side effects. They are not sure how long I will need the medicine but they think it will only be a short period of time.
Just as the doctors took action in my example central bankers have taken action over the last many years. Japan in essence went though a down cycle and their central bankers determined it was going to be to dangerous so they prescribed “Quantitative Easing or QE”. Later the USA was faced with an impending great recession and they to prescribed QE.
Lastly Europe joined the bandwagon of QE. During this QE bankers drastically lower interest rates. In many cases they lower them to less than zero. I know it sounds weird but they do it. They also borrow exorbitant amounts of money to keep unsound businesses sound. They save the businesses that are too big to fail. If that business was going to fail clearly their was some amount of waste or inefficiency in the system especially if it was to big to fail.
So in the downturn of our business cycle the central bankers stepped in and hit the “PAUSE” button. Remember these are smart people. They determine they can hit the play button at any time and everything will just start humming again. They intend to just cut off the worst part of the down cycle and when we are past the worst part they will hit play and away we go with the next cycle.
Getting back to my stomach bug example. Eight years go by. The medicine is keeping me from getting really sick but I never get any better. In fact I am slowly getting worse and on top of that I now have artificially inflated man breasts. The doctors now feel the risk of getting off the medication could be disastrous basically worse than before they made initial prescription 8 years ago. What I need they tell me is more medication.
Back in the real world, central bankers around the world have prescribed QE and more QE and even more QE. Part of that QE is 0% interest rates as I stated earlier. This allows companies to borrow money at very very low rates. The only problem is we have not yet purged all the inefficiencies in our systems from the last downturn. All the over investments that were built in the last boom cycle are all mostly still running.
The 0% interest rates allows inefficiencies to stay in place. Major corporations faced with no growth have to do something or the CEO will lose his/her job. Faced with no growth and easy money they borrow lots of money to buy their own stock. This is not a bad thing. Faced with no real growth opportunities because we are “PAUSED” in the last cycle business they must do what they can. Doing what they can puts a great deal more debt on the balance sheet of our businesses. This in turn will make circumstances that much worse when it come time to raising interest rates because now we have a great deal more debt in two areas, the government and our major business.
The US central bankers are contemplating after 8 years pressing the “PLAY” button. They may raise interest rates. It is their conjecture that we are past the worst part of the recession (which was 8 years ago). The only issue is the side effects from the prescription are still hanging around.
In the example of my stomach flu. I am not going to get any better until I get the chance to purge the bug. It is the same with the US.
One of the many side effects of medication and the “PAUSE” is the effect on China. When China became the maker of products for the world they were in their infancy. They had no infrastructure and no real capabilities to speak of. What they did have was cheap labor. As we began to ship our manufacturing to China they had to build everything from scratch. The worlds demand for cheap Chinese products was immense. China had a huge period of growth to try to catch up to the world’s demands.
During this time of extremely high growth they had to build manufacturing, roads, housing and everything else necessary to meet the demands of their people and their customers. For many years this growth was over 30%. China grew to where its economy was close to the size of the US economy. During this time it is important to understand the individual pieces of its growth.
They had internal growth for things like infrastructure and business growth to meet its customer demands. Since they were really never able to keep up they didn’t have large business cycles as the need was always greater than supply. Ten years ago the Chinese economy was approaching the size of US economy. When you have an economy that size, 20% growth is enormous. During their growth period some % of the economy was part of building out the growth and some % was actually filling the product needs of the world.
At some point the worlds largest countries started hitting the “PAUSE” button. Japan first, then the US and Europe. At the same time China got to the point where they could meet the needs of world with their current built out capabilities, but a large % of their economy was dedicated to growth. China kept growing at 20% to 30% while the rest of the world was “PAUSED”. At some point they outgrew the need.
That is why you see China today in the predicament it is in. They most likely overshot the worlds needs by a good ways. If for example 25% of China’s economy was made up of building out the growth, that 25% is now pretty idle as they are not mostly likely overbuilt for current world demand.
Many pundits say China is the cause of our stock market troubles in August and September. The global “PAUSE” is what caused their ills.
They make our products. When Japan, the USA and Europe decide to hit the “PLAY” button China will exit their down cycle and most likely not until.
Who knows what will happen when we try to eliminate the prescription from our central bankers. It is my belief the medicine is causing more harm then the disease. This is just my opinion and I hope it helps!