The Next Crisis

Will there be Another Economic Crisis Like 1929 or 2008?

Yes and soon. Because the Federal Reserve inordinately expands credit and hence purchasing power, according to the Austrian business cycle theory, this distorts the capital structure by achieving growth unconnected to real savings. In 2020 the economy will start its descent down. This will specifically be triggered because the Federal Reserve Bank has kept the Fed Funds Rate too low to too long. They try to match it with R* an empirical proxy for the natural rate of interest. However, this econometrically estimated rate is incorrect and creates systemic distortions in the capital structure.

Therefore, the current boom is unsustainable.

Buckle your seatbelt Dorthy because Kansas is going bye-bye.


Prognosticators and writers perpetually forecast doom and gloom to make the news.

Live every day as it were your last – and someday you will be right.

One of my favorites is:

However, let us look at the real economics of a business cycle. The underlying premise is when the pricing mechanism fails, markets will be in disequilibrium. The price of money or its derivative credit is the interest rate. This is the key price we are talking about here.

What causes an economic crisis, collapse or panic?

Prices mean something. The Interest rate is the own rate on money. It is a price of money in one sense. Because this is controlled by a central bank rather than the free market then, any overestimation or underestimation will create a disequilibrium that will manifest through either the price level or malinvestment in the capital structure.

The Wicksellian natural rate of interest is the rate of interest that would exist if barter ratios were used. That is if money did not exist. Fed Policy tried to match the natural rate with the market rate. When there is a divergence there is a cumulative process of price or capital distortions.

This happens because disequilibrium in a singular market like potatoes mostly affects the potato market. But disequilibrium in the money market works its way out across all markets.

From another perspective, it is because financial assets in a particular sector are valued above their natural value. Natural value is the value they would have if expansion is fueled by real savings rather than artificial stimulus by monetary or fiscal policy.

This means some part of the financial sector is mis-priced. What this really means is a set of prices in a particular market have departed from the trend or their natural intrinsic value.

After this divergence between the aggregate nominal price and the natural price, eventually, that sector tries to adjust itself because investors see the difference. When the financial correction of price or valuation comes, it subsequently sends a shock wave that affects the real economy, that is factors like production and employment.

Therefore, the cause of a crisis is the wrong aggregate market prices in a particular financial sector. It could be technology stocks or mortgage-backed securities or it could be the bank interest rate (the price borrowing money). However, some aggregate price in the financial markets is incorrect. The entire financial sector is not always mis-priced, but usually one particular sector. The reason people do not see the next crisis is the sector out of equilibrium is usually different in every crisis, further, information is imperfect.

However, it starts with the interest rate.

What is a Natural Price?

If the nominal price is what you see quoted in the market, determined by supply and demand. The natural price is some valuation of what the financial asset should be priced at. This is a theoretical price and it is open for debate and have been debated by the great economics from Hayek to Keynes. Even if there is not perfect determinate model for natural value, It is a theoretical concept that provides a framework for understanding cycles. I am only giving examples to illustrate.

For example in a Wicksellian or Austrian economic model of business cycles, the natural rate of interest might be equated to the marginal productivity of capital. While the nominal price is the interest rate you see at the bank. If you are looking at real estate prices, the Case-Shiller Home Price Indices is a good index to follow in relation to the 200-year trend in real estate prices. For stock market valuations some people use book value as the long-run indicator of where a stock should be priced. Again the natural or true valuation is purely hypothetical because of the marginal revolution in economics correctly model prices as subjective.

What is natural price
If natural price were as observable as market price, there would be no business cycle.

Why do prices get valued wrong?

The issue is the economic world is always changing and factors like expectations weigh heavy into the equation. It is realistic expectations that cause the divergence. Expectations are based on imperfect information about the future, and social trends. Prices are the equilibrium clearing point, but they have expectations about the future embedded into them. This is what makes economics a social science.

No person can predict the actions of another – Mr. Spock

  • Therefore – A crisis or panic is caused by an expectational price bubble in the financial sector, playing out when prices are inflated in relation to natural value. When this becomes manifest to the majority of investors the spark ignites a collapse. Rarely is real sector disequilibrium a factor in a crisis.

This is in contrast to long-term structural problems that come gradually, crashes are swift because there is a temporary disequilibrium between supply and demand. Disequilibrium between supply and demand is caused by financial disequilibrium that spread to the real sector.

Think about it, a farmer is less likely to miss-price a bushel of wheat when he brings it to market than people who speculate on MBS securities or stocks in the financial world because the values of these financial assets derive their value from another underlying set of asset in a complex, convoluted relationship that even the rating agencies miss.
Warren Buffet was wrong when he said:

The stock market is the perfect weighing machine.

In reality it is an imperfect weighing machine based on imperfect information.

My premise is every financial market is imperfect. When the imperfections grow there becomes a metaphorical crack in the system that spreads and damages the structure of the economy.

  • Therefore, it is when price departs from natural value, then an imperfection is caused. If price and natural value are too large in aggregate, there will be a correction. if the correction is large there is a displacement of money that spreads to the real sector.

So how can we predict where and when the next crisis will be?

Do not listen to an Economist who is looking at large demographic tends, politically motivated or are selling a book writing about baby Boomers and Millennials. Rather always focus on prices of financial assets that deviated from the long-run trend in an unnatural way. I do not have the time analysis balance sheets or like Dr. Micheal Bury did in predicting the housing market crash, however, you can look at trend lines.

What are the main markets to watch that trigger an economic collapse:

  1. Interest rate market – The federal reserve bank interest rank to the marginal productivity of capital.
  2. Stock market by sector – historical valuations of a particular sector and deviations from the long term trend.
  3. Housing market – prices that are well above the long term inflation adjusted long term trend.
inflation and recession can exist simultaneously
Do valuations look strange to you?

How you know a crisis is coming?

Above I gave you the economic explanation. But a common-sense way is this, take a look around do people live like they are rich and decadent? Think of the roaring 1920s or the years before 2008 and how people were living and compare this to today. I think people have a subdued caution and many people are scraping by. This in my opinion does not feel like a bubble. Since 2008 was in our recent member we are more diligent and watchful, this adds to a conservative feel about how we conduct our economic lives. We all feel poorer rather than inflated with money.

Forget the news, look around you. Are we booming or trudging along? If we are trudging there is no speculative bubble.  Are people eating at McDonald’s and chain restaurants in your area or spending a lot or gardening more? Where are people going on vacation? Europe or hiking in Asheville? Do people have multiple homes they are renting for investments or barely paying the bills for one?

boom or bust cycle
Economic theory aside, the best way to determine if we are in a bubble is look around you. Do your surroundings look like a Great Gatsby party or a scene out of the Waltons? In 2017 I think it looks more like the latter. If there is no boom there will not be a bust.

There are weaknesses in the economy but these are mostly long term structural problems that the next administration may or may not fix, I think Trump will couple with some favorable supply shocks like the discovery of new Texas oil fields. No one knows, but again take the common sense test of looking around you and see if people look and act like they are in the 1920s or just coming out of the 1930s? I tend to think the latter.

Besides the theory of prices, expectations and business cycle, what are the weights on the US economy?

The structural decline is not the same as a crisis and rarely triggers anything but a slow painful relative decline in wealth. A collapse happens in a year or less.

  • Other factors that might feed into a crisis are as follows, they cause both structural and potential for cyclical issues
    Excess Federal State and local debt – – The federal debt has exceeded national income. The amount is increasing every day. Politically motivated writes will tell you that debts and deficits are not issues because the US can always repay with taxes. Translation, your money. They write this because Obama created the largest deficient in history and they supported the former President. The truth is government debt might not cause a panic yet, but it suppresses the economy to such a level that it eventually will. Government spending crowds out private investment decreases family income and will cause an economic crisis unseen before when the US can no longer pay its obligatory payments. The debt has a dampening effect on the US
  • Economic factors for an economic collapse rated from biggest factors to least.
  • Excess consumer debt
  • Low savings rates
  • Real wages are not increasing
  • Housing bubble – bubble/
  • Rates are so low for so long that a small increase could affect the economy
  • Excess money created through central bank policy could cause inflation
  • Banks are unstable – facing the light of regulatory justice has weakened their capital adequacy.
  • Socialist policies of Obama administration have cause market distortions
  • European problems spread to the US markets
  • Unforeseen – Each economic crisis is caused by something that did not cause the last.
  • Austrian business cycle – Difference between the marginal productivity of capital (lets say the profit rate) and the bank lending rates causes a cumulative process of disequilibrium.
  • Fraud continues – Regulators penalties amounted to a fraction of the perpetrator’s profits. Few, really only one person responsible for the last crisis, went to prison, thousands of executives who engendered the fraud that caused the last crisis are free. The message from the government regulators is, crime pays if you do a cost-benefit analysis. This is unfair and will bring a new generation of greed motivated Wall Street cowboys to who will do the same. The regulators were too easy.
  • Big banks know they were bailed out last time and the message is they will be bailed out again. If they were left to fail, a more efficient honest banking system would have developed, even if there was short-term pain.
    If you don’t remember anything else I say today, please remember this: Only about 20 financial institutions perpetrated this crisis. These 20 failed in every respect, from business practices to ethics. Greed and malfeasance were their modus operandi. There was no excuse for their behavior, and they should be punished thoroughly, perhaps even criminally. Richard Kovacevich, the former chairman and CEO of Wells Fargo.
  • Monetary policy is still being directed by the Federal reserve, rather, than the market. Therefore, the supply and demand for money is not efficiently brought to equilibrium.
  • Fear – It is a strong human motivator
  • World event – that triggers a shock
  • Weather pattern changes causing an economic shock in the primary sector. This theory was populated among economists who tried to explain the Great Depression starting with the Dustbowl.

Positive structural fixes to the economy

  • Cheap unlimited oil discovered in Texas
  • Trump economic reforms on par with Reagan
  • Innovation creates a positive supply curve shift.

What if there is an economic collapse?

Do not worry. I lived in Poland much of my life in a post-communist country. People survived and thrived, educated themselves and had magical lives with literally no money. In fact, in many ways, it was a richer life. You will adjust the way you spend your time and money. You might grow your own food and read the book and discover there is more to life than slaving away at a career and spend more time with your family.

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4 responses to “Will there be Another Economic Crisis Like 1929 or 2008?”

  1. Alex22

    After Communism fell and the Russian soldiers left Poland there was a boost of the spirit. With that new spirit they rebuilt Poland.
    There is a completely different situation in the USA where they have a Communist President (Obama) who could not care less if he causes a collapse as long it is in the name of Socialism. Therefore, the USA is just heading where Poland was in the 1980s. I think for a change so drastic the term “collapse” is appropriate.

  2. Marc Jordan

    It actually sounds like you are bullish on America, something I have said here for a while. However, I would be running around with blinders if I didn’t see the current situation as somewhat concerning. The debt rises yet Washington refuses to do what is right by lowering spending and raising revenue. As I’ve said here many times, there has to be “some” waste in the Pentagon’s nearly trillion dollar per yearR budget, yet the current Secretary of Defense’s predecessor said that the mandatory sequestration cuts to the military will be “devastating”, and that was only something like 2-3%.

    How we are going get out of this mess only God knows, but in case you want to know how we got to this point, here is passage from a New York Times OP ED that David Stockman wrote last week. For those of you who don’t remember, Stockman was Reagan’s Budget Director.

    This dynamic reinforced the Reaganite shibboleth that “deficits don’t matter” and the fact that nearly $5 trillion of the nation’s $12 trillion in “publicly held” debt is actually sequestered in the vaults of central banks. The destruction of fiscal rectitude under Ronald Reagan — one reason I resigned as his budget chief in 1985 — was the greatest of his many dramatic acts. It created a template for the Republicans’ utter abandonment of the balanced-budget policies of Calvin Coolidge and allowed George W. Bush to dive into the deep end, bankrupting the nation through two misbegotten and un-financed wars, a giant expansion of Medicare and a tax-cutting spree for the wealthy that turned K Street lobbyists into the de facto office of national tax policy. In effect, the G.O.P. embraced Keynesianism — for the wealthy.

    Here is the whole piece:

    1. Alex22

      If it was an easy job to identify who caused thecollapse: Right-wing (Republicans) or Left-wing (Democrats), then we would know the answer by now. But, both are spending money like drunken pirates. So who created the present debt? They (the politicians) all did it. And unfortunately they did it with the full support of the voters.
      I think that that one of the best simplifying model is: Capitalism created Socialism and Socialism bankrupts our financial/economic system.
      In the First World’s system to see the fallacy of only the Left or the Right will never give you more then only 50% of causes/solutions of the problem.
      You Marc blaming Reagan for the present debt and financial and economic problems is ludicrous.
      Of course, the big question is: If neither the Left nor the Right, then who has the solution for the 21st Century?
      Have a great day.
      Alex J

      P.N.: The collapse already has happened. Can’t you see it?

      1. Plasticmoney888

        Good points but to mention: “Unfortunately they did it with the full support of the voters.” Uninformed voters can be much more dangerous than non voters.

        In a liberal and limited democracy people are supposed to make their value judgment not the opposite and certainly not choosing people that will make them on their behalf.

        The US limited democracy his progressively being inverted and is being purposely corrupted. Government is becoming a very costly Master and its citizens are becoming its servants.

        The accumulated deficit now stands at 16.8 trillion and I would bet that more than half of voters don’t understand the difference between the deficit and the debt.

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