von Mises Crack Up Boom could follow the negative economic effects of war
There is currently much hype in the media about a hawkish Fed because the media wrongheadedly anticipates rate hikes due to the “inflation” being caused by rising oil prices (directly and indirectly). Furthermore, CME traders, often little more than a wind sock indicating current sentiment as opposed to accurate forward forecasters, have completely backed off their previous view of rate cuts, and now increasingly favor a rate hike this year.
Perfect!
Trigger (Event) & Lever (Response)
Official (i.e. Fed and government) macro operations need a trigger and a lever. The trigger will most likely be a market liquidity event with a deflationary overtone to call the Fed and Trump administration into inflationary action (printing and spending).
While everybody is currently worrying about war, oil, knock-on cost effects and calling it inflation, these conditions will only shove an already sluggish (at best) economy into deceleration and possibly, recession.
Those effects are the trigger to official action. The lever that officials will pull is the oldest inflationary trick in the book. In tag-team style, he Fed pulls the lever half way as it opens the monetary spigots by some combo of Funds rate cuts and bond market asset purchases (a polite way of saying bond market “manipulation”). The government then shoves the lever as far as it will go in the ‘on’ position, injecting the Fed’s newly created “money” into the economy as spending, bailouts, tax preference, war funding, etc.
Ah, but in Q1, 2020 under Trump 1.0, the Powell Fed pulled the lever so hard it broke and could not be stopped from releasing epic inflationary inputs that the government then used to spray the land with newly printed money. It’s my colorful way of saying that this was the most intense monetary bailout over decades of periodic bailouts. It was also the last of its kind. So says not me. So says the bond market (see below).
That was the true beginning of the most recent inflation problem. It got worse under the Biden administration, when government not only did not address the inflation (and the Fed was way too late in doing so), it promoted it from a fiscal perspective, before Jerome “he’s always late” Powell finally took up the fight. You may recall my favorite image from that period as Powell (with a little Treasury Secretary Yellen in his ear whispering “transitory, Jay, transitory… “) finally took up the inflation fight long after I, for one, had insisted they’d better do so.
But inflation was birthed in Q1, 2020, just as NFTRH noted at the time in real time.
Prior to the war in Iran and the spike in oil and other prices that people are calling “inflation”, a disinflationary phase was ongoing. It still is. What is happening now are external events driving up certain prices. The Fed will not act to inflate against these rising prices. The Fed will wait, like the cynical vampire it is, for the economy to decelerate with recession risk rising.
You have to invite the vampire into your house, and when you do, he will do what he does. In this case, when peoples’ attention has turned to the likely economic fallout from the combined pressures of rising oil (and knock-on prices) the already suspect economy will have started rolling over. And you just watch how hard oil prices go in the tank.
We will then have another of those macro whipsaws where the herd was worried about one thing and then finds itself terrified of the next thing? Thinking I’m pulling this out of thin air? Look no further than the hysterical “PEAK OIL!!!” top in 2008. That was the final play of the widespread “inflation trades” that ran from 2002 until the cash of 2008. The deflationary crash of 2008.
As it was then, it is important now to tune out supposed experts advising about what you see in front of you today. Back then big names like T. Boone Pickens and many lesser promoters jumped the pump advising you of the horrors of peak oil. Well, trough oil was only months away. That is how quickly macro whipsaws can play out in a system where it’s ‘inflationary wax on, err ruh roh, inflationary wax off!’
The deflation scare that followed sprang our heroes at the Fed into action, printing new bull markets, asset price increases and inflation, as if by magic. The main initial beneficiaries were the Pigs, that is the banks, and other troubled financial institutions. But the inflation was inflicted upon all the people, most of whom are impaired by inflation, not beneficiaries of it like the asset owner class (stocks, real estate, etc.).
Fat cats get bailed out and continue getting ever richer through the asset price-increasing wonders of inflation, the middle got squeezed hard, and the lower? Well, let’s just say you had the makings of a lurch toward Socialism that eventually fomented the coming of MAGA and Trumpism.
All that damn political noise asise, a whipsaw in the direction of ‘deflationary’ is the trigger to the next inflation. As it was in 2001, 2008, 2020 and… will be before 2026 is done (my educated guess).
Crack Up Boom?
The trigger is expected and if it arrives in the form of a deflation scare, the lever will be pulled. It will be done from the heights (or is it depths?) of indebtedness. US public debt has now climbed to $38.5 Trillion.
A country that is not able to cover its obligations, but instead, continue compounding debt in unfettered fashion, while printing “money” as needed…
…and running its economy on this ability to create more credit/debt, is trapped into creating more debt so that it can create more inflation in order to run our inflation-fueled economy. Simple. And scary.
The uptrend in this Debt-to-GDP chart advises that while our GDP may be rising over the long-term, the debt supporting it is rising much more aggressively.
Bottom Line: The damn economy runs on the ability to manufacture credit, turn it into printed dollars, and spew it into the economy.
From mises.org we can put to bed this crap about how oil is causing inflation:
Economically speaking, hyperinflation is the inevitable consequence of an ever-greater rise in the amount of money. And this is exactly what the monetary theory of the Austrian School of economics teaches: In fact, Austrian theory shows that inflation is the logical consequence of a rise in the money supply, and that hyperinflation is the logical outcome of ever-higher growth rates in the money supply.
In our modern system we use US debt instruments (Treasury bonds) as collateral of sorts to allow the Fed to print dollars into existence. That’s inflation; inflation created from debt obligations already at head spinning levels. Where will it stop? And how will it stop? Inflationary crack-up or Deflationary “pffft” down the drain?
To the point of 2020’s blown gasket finale to the old macro (RIP technically, 2022) confidence in the old way, supported by the former disinflationary trend in long-term Treasury yields, was intact. Confidence “was” intact.
More from mises.org:
The Unrelenting Power to Inflate
If people expect a forthcoming, drastic increase the money supply — but if they at the same time expect that such an increase will be limited (i.e., a one-off increase) — the central bank can actually orchestrate a debasing of money without causing its complete destruction. As long as government and its central bank succeed in making people believe that any future rise in the money supply will remain within an acceptable limit, from the viewpoint of the money holder, monetary policy is an effective and most perfidious instrument for expropriation and non-market-conforming income redistribution.
The old macro is done. Powell blew a gasket and was quite tardy in addressing the inflation his Fed created. Confidence was indicated lost in 2022 when the Continuum broke the gentle, decades-old downtrend to the upside. Debt is the thing that is at issue now. And the trend in the manageable creation of that debt has broken, per the chart above.
What does the economy run on? Debt. The Debt-to-GDP chart above is a sad and frankly, scary fact, not fiction. It is debt that is at the heart of a would-be Crack-Up-Boom discussing the role of debt in the process.
Debt Levels
Today’s fiat-money regimes are characterized by ever-greater amounts of debt relative to real income — caused by policies that try to solve the economic problems caused by credit and money creation out of thin air by using even greater amounts of credit and money created out of thin air. And it is fair to say that the higher an economy’s overall debt level is, the more likely hyperinflation becomes.
To show this, let us assume that after a long period of money creation through bank circulation credit expansion a credit crisis emerges: Creditors are no longer willing to roll over maturing debt at prevailing interest rates. Borrowers cannot repay their obligations when payment is due, and neither can they afford paying higher borrowing costs. Investors start fleeing out of bonds, making interest rates increase sharply and thereby covering up unprofitable investment. More borrowers, including banks, fail to meet their obligations, and bankruptcies spread. Ensuing recession and rising unemployment aggravate the collapse of the credit structure.
Should investors in such a situation expect that the government and its central bank would opt for bailouts financed through additional money creation, the demand for money and fixed claims would most likely dry up. This would make it necessary for the central bank to extend ever-greater amounts of money to struggling borrowers in order to prevent the spread of bankruptcies. The larger the amount of outstanding debt is, the larger will be the potential increase in the money supply. The more the money supply grows, the more likely it is that there will be hyperinflation and a potential breakdown of money demand: the unfolding of a crack-up boom.
Bottom Line
- My expectation is for the current oil-driven inflation hysteria to ultimately flame out.
- From this we resume down the disinflationary path with a liquidity crisis and deflation scare ahead.
- This liquidity crisis will be the trigger to springing monetary and fiscal inflators into action.
- The Fed (monetary) will pull its lever half way, monetizing debt and printing money.
- Then it will hand off to the government (fiscal), which will pull the lever the rest of the way.
- At first it is expected that this will feel relatively okay as asset markets recover.
- What comes after – due to a system saturated with inflation from decades of previous operations – is Stagflation, a hyper-inflationary Crack-Up-Boom or something not yet named. Oh, but it will be named because it will be painfully memorable as a historic economic and social low.
Scary, eh? Yes.
But now I go back to my job, which is capitalizing on all of this and advising subscribers of accurate macro interpretations, to the best of my ability. Today is Friday. The stock market is doing as expected eyeballing our downside targets, and I for one am well lit up in the green. And it’s not just due to gold stocks and commodity-related stocks doing well today.
In line with our ongoing analysis, I am temporarily short SPX, NDX, SOX and long the VIX using related instruments and short a couple of over-exposed Tech stocks to boot. * All while being long stocks in a diversified manner because I expect the biggest move in 2026 to be bullish upon the completion of the current market correction. The rationale for being temporarily bullish are found in the trigger and the lever. The bailout to come, if the current view is correct.
* The only fly in the ointment could be whatever will come out of the TACO’s mouth over the weekend. In other words, for most people cash should be the primary risk management tool during bear phases.
