The Growth Hype Cannot Hide the Possibility of Another Financial Crisis Lombardi Letter 2018-09-12 11:50:37 us dollar debt national debt us treasuries 2008 financial crisis federal reserve us debt The Dow Jones Index continues to hold at record levels, hovering close to 26,000. But don’t believe the growth hype. Debt has raised the risk of a major financial crisis. Analysis and Predictions,Inflation,News,Stock Market,Stock Market Crash,U.S. Dollar,U.S. Economy,U.S. Politics,World Politics

The Growth Hype Cannot Hide the Possibility of Another Financial Crisis

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Don’t Believe the Growth Hype; Debt Has Raised the Risk of a Major Financial Crisis

The Dow Jones Index continues to hold at record levels, hovering close to 26,000 points. But how long can the bull market continue? It’s time for investors to start pondering that question; that is, before the start of a long overdue financial crisis.

The U.S. Federal Reserve’s hints about slowing down the pace of interest rate increases have not helped. Rather, rumors to this effect have put a tailwind on a stock market that was beginning to show signs of healthy self-doubt.


The Fed’s monetary easing and low interest rates worked their magic in helping stocks recover after the 2008 financial crisis.

Yet the Fed’s policy of raising rates at regular intervals, starting at the end of 2015, has not helped cool down the speculation instinct.

That’s not as optimistic a scenario as it sounds. The Fed did not announce plans to reverse the hikes; merely to slow them. And rising interest rates, regardless of their extent, have always produced a drop in stock market valuations.

As it happens, price-to-earnings (P/E) ratios, a key if somehow forgotten metric in the case of certain stocks—I’m looking at you Tesla Inc (NASDAQ:TSLA)—have started to fall compared to the resumption of rate hikes. (Source: “Stocks are in ‘the danger zone,’ and it is ‘assured’ that a bear market will occur in the next year, analyst warns,” MarketWatch, September 10, 2018.)

The Performance of the Current Market Has Defied the Odds

Key interest rates have risen while investors have not so much as expressed the slightest hesitation.

The stock markets, in that sense, have defied history.

Investors should be more afraid than enthused because the current trend suggests that everyone is still behaving as if in a state of stupor. The hangover in due time will be even more dramatic and painful.

It will be hard to stop the resulting crash from evolving into a full-on financial crisis.

In addition, U.S. Treasury yields have also been increasing. The 10-year Treasury note has reached a level just shy of three percent. Nobody knows what the psychological threshold might be now before investors take notice and pull away from stocks.

The difficulties of countries in emerging markets like Argentina and Turkey, which could suffer more blows as the Syrian government moves in for a final offensive to retake control, have pushed the dollar higher.

In a situation of higher tariffs, or the threat thereof, the dollar would serve Americans better if it were low.

The Dollar Has Moved Too High for the Good of the Global Economy

Despite President Donald Trump’s efforts, the U.S. economy does not operate in isolation. Its health also relies on the good health of others.

Instead, the higher U.S. dollar presents significant risks in the wake of higher trade tariffs. (Source: “Three Ways The Strong Dollar Is Impacting Your Investment Portfolio In 2018,” Forbes, August 13, 2018.)

Trump Wants Low Rates Rather Than Steady Increases

Could Trump’s attitude to interest rates explain why the markets are continuing to hover around the Dow’s January 2018 record?

President Trump has made no secret of the fact that he doesn’t like the high dollar. After all, he appointed Jerome Powell to the role of Federal Reserve Chair to continue with his (apparent) dovish attitude to rates.

The recent set of macroeconomic data (i.e. job numbers) showed that job growth (however precarious those jobs may be) continues. Even salaries have started to go up. (Source: “U.S. Wage Gains Pick Up to 2.9% While Payrolls Rise 201,000,” Bloomberg, September 7, 2018.)

Nevertheless, the wage and employment story represents a clear case of the old saying “all that glitters is not gold.”

Wages should have been rising at a much faster pace, given the tighter U.S. job market. And that reveals a well-known secret about the current economic recovery: It’s nothing to write home about.

The Tax Cuts Have Distorted the Entire Economic Picture

Tax cut-driven growth has put enormous strain on the already dangerous debt situation in the United States.

After all, how did you suppose the tax cuts were being financed? Yes, it just goes on the debt bill. But that’s what makes the growth so hollow.

The real economy can’t sustain it, and the out-of-thin-air financial economy has become one tax cut-fueled bubble, whose continued ability to tolerate a bull market defies logic.

Still, the Federal Reserve cares little about where the growth comes from. Its main goal, a veritable obsession, remains to control inflation.

Despite the rumors that the Fed was planning to slow down the interest rate hikes, the job and wage figures compel it to continue along the rate hike path.

And that’s when the proverbial “fun” begins.

The interest rates will put U.S. household debt in jeopardy. Everything from credit cards, to mortgages, car loans, and student loans will be harder to pay off. The rates will remove that veneer of the “middle class” lifestyle, however usurious in origin, from most American families.

Years of ultra-expansive monetary policy, with nominal rates near zero, have made families accustomed to resort to debt in lieu of stagnant (if not declining, compared to inflation) wages and high unemployment.

Debt Keeps the World Turning

Moreover, businesses and governments have also used debt to keep the economy moving.

No government, least of all that of the United States with its $21.0-trillion-plus national debt, has learned to give up this instrument.

Now that interest rates are going up, Washington and many other capitals around the world—even those in Europe, starting in 2019—will face the risk of a debt blow-up as rates increase everywhere.

The result of all this dependency at the global level means that the world owes some $230.0 trillion. All it takes is for one or two countries to go into default to trigger a domino effect.

Given their relative weakness and the need to buy U.S. dollars—which higher Fed rates have made more expensive—emerging markets should be a great cause of concerns for investors.

The Prospects of Another Global Financial Crisis Are Considerable

The higher-value dollar has emerged as the trigger. In emerging markets, the dollar effect accelerates and compounds the effects of a financial crisis because it triggers capital flight.

Those who can, buy dollars or Treasuries to protect their assets and savings. Argentina and, to a lesser extent, Turkey have already experienced these situations over the past summer. But it’s merely the beginning.

The fact that debt and default risks are inviting a new financial crisis does not discount the potential economic damage that could result from fears of a trade war.

And that’s where Americans should be most careful.

In a world full of tariffs, a high dollar penalizes U.S. companies and workers.

Only real economic growth, the kind that does not need radical tax cuts, will be able to save America and the world from taking the path to a financial crisis.

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