The End of Cheap Money Is About to Trigger a Paradigm-Shifting Stock Market Crash
President Donald Trump’s policies to revive the U.S. economy may end up backfiring. Like a hot rod driver who hammers the power too quickly in a drag race, investors are going to skid out of control in a massive stock market crash.
The cause has been discussed for months, but it doesn’t hurt to repeat it: low interest rates have allowed investors to confuse investing for a financial joyride on Wall Street. And it’s about to turn ugly, as the end of “cheap money”–that is, low interest rates–can no longer be postponed.
What’s more, the consequences of a stock market crash would have incalculable consequences for the global economy. That means recovering from it becomes more difficult.
The European Central Bank (ECB) has yet to reverse its near-zero interest rate policy. A U.S. stock market crash would inevitably activate a domino effect. European and other central bankers would be unable to steer their economies away to safety–they, too, would collapse.
At their fall shindig in Bali, even the experts at the International Monetary Fund expressed concerns that the global economy will grow at a lower-than-expected pace in 2019. (Source: “FTSE 100 hits six-month low as IMF slashes growth forecasts – business live,” The Guardian, October 9, 2018.)
It May Not Be Tomorrow or Next Month, But It’s Coming
You can count on the stock market crash as easily as you can count on the preacher saying “Hallelujah” at some point during the sermon. And the analogy is not gratuitous, given that Trump has already unleashed all the economic arsenal at his disposal to stimulate the economy.
The Federal Reserve rates have increased, but at 2.25%, they’re still too low for Chairperson Jerome Powell to reverse raising the effects of the hike.
Moreover, rising concerns over America’s new pro-tariff, mercantilist approach to trade suggest the curtain is closing on the era of globalization. That’s not a bad thing in itself, but the urgency of its implementation will send shockwaves through interlinked economic arteries, which cannot break without dragging investors around the world down with them.
Banks don’t have enough buffers to survive another 2008 financial crisis. Any hint of a bailout as a fix would bring the pitchforks to Wall Street and Pennsylvania Avenue.
This is a problem that ballooning personal debt buildup at all levels, from mortgages to credit cards and car loans in between, has made even more alarming, especially in the United States.
The past—and we need not look too far back, since the Lehman Brothers collapse happened just 10 years ago—suggests that the kind of debt accumulation of the present triggers a stock market crash and a related economic crisis.
A Distorted Recovery
The post-2008 recovery has been distorted by low interest rates in the midst of a structural revolution that has consolidated a shift in production away from the developed economies to the emerging ones.
Normally, in the boom-bust model of the post-War economies of the industrialized world, recessions were normal phenomena. The harsher ones, such as the one that the 1973 oil embargo caused, had protracted effects, but the solution was always to facilitate more production and a better distribution of income.
The 2008 crisis, on the other hand, was caused by banks. It was a banking crisis which had a government bailout as a solution.
Considering their guilt, the fact that the crisis wiped out only one or two major investment banks was a miracle. Certainly, there would have been no miracle without more than $1.0 trillion in taxpayers’ funds.
Yet the banks failed to return the favor. They were tight with the kind of credit used to rebuild traditional economies while exercising excessive generosity when it came to the kind of debt to fuel consumerism.
The banks, meanwhile, did not cease to practice the financial alchemy that got them in trouble in the first place with the subprime collateralized debt obligations and other derivatives.
Tax Cuts Have Been the Steroids of the Economy
Trump’s tax breaks and tariffs may have created the impression that higher-paying jobs are returning and that corporate earnings are increasing.
What will happen when the tax break effect ends? That is when companies report their 2019 earnings.
The increases won’t be as palpable as they have been this year. The tax breaks, like the low interest rates, have generated an effect not unlike that of nitrous oxide on a hot rod—the same one that lost control at the start of this article.
The Dow Jones may continue rising or hovering at about 26,000 points for the next few weeks or months. It’s like a highway bridge that engineers warn is showing signs of weakness. It doesn’t fall immediately, but then, when nobody expects it, it does fall, causing deadly damage.
If that scenario is familiar, it’s because it materialized last on August 13, when the Morandi Bridge collapsed in Italy, killing 39 people.
The Time to Panic Is Now
The stock market bubble could blow at any moment because the economic framework has become less than reassuring.
While some of the economic indicators, like job growth and even rising wages, are welcome, the current financial instability caused by debt is the equivalent of a tall building resting on weak and crumbling stilts.
The 10-year Treasury yields rising and their effects on the U.S. dollar will force the Fed to push interest rates higher. After years of quantitative easing, every hike becomes more delicate, making a stock market crash more likely.
What the Treasury yields imply is that if you or your friends lend money to the U.S. Government in Washington for a period of 10 years, you earn 3.2% back. That’s the highest return in almost a decade.
It will simply attract investors away from higher-risk equities back to government bonds. A similar process should occur in Europe when the ECB also acts on interest rates.
Moreover, the strength of the U.S. dollar is relative. The exchange rate compared to its more significant rival, the euro, is reaching for parity because the ECB has yet to reverse the quantitative easing monetary policy. As a result, the dollar is inflated.
Higher Treasury Yields Are Sending an Unequivocal Warning
The higher Treasury yields reflect the unusual strength of the American economy, yet they also contain the very seeds of the next stock market crash.
Meanwhile, Trump’s tax cuts act like another economic stimulus plan. They contribute to a sense of false or fleeting prosperity–and won’t survive the higher prices and higher interest rates.
But because of the 2008 financial crisis and the solutions to recover from it, private and public debt in the United States will become more expensive to service. And for many individuals and countries (Turkey and Argentina, for example), it would cause life-threatening economic circumstances.
Such is the context in which Trump has launched his mercantilist attack against globalization. This can work insofar as everyone wants to trade with the United States.
Should the next stock market crash prove as violent as many expect, the tariffs will bite back against American investors and consumers alike.