By May of this year, it became impossible to ignore the underlying weakness in the economy. Though the signs were plainly visible for most of 2018, particularly in housing, autos, and retail sales, it was not until the yield curve finally inverted in early spring that investors took notice. Typically, yields on long-dated Treasuries only fall below the yields of shorter-dated Treasuries when the economy is moving toward recession. While many analysts offered theories as to why this usually reliable recession predictor was no longer valid, the fear began to spread.
Then in recent weeks, the economic data turned much softer. Deterioration accelerated in the housing market (where the lowest mortgage rates in years have failed to translate into home sales or mortgage origination), in factory orders, industrial output and consumer spending. New data from the auto market revealed that the time needed to sell new cars has not been longer since the recession year of 2010. Auto, credit card, and student loan delinquencies also rose to levels not seen since the Great Recession, according to data from the NY Federal Reserve Bank. The anxiety was ramped up this week when ADP released its worst employment report in almost a decade, showing only 27,000 private sector jobs created in the month of May. Ominously, the biggest losses were in high paying goods-producing jobs. That was followed up by the Labor Department's release of a much weaker than expected 75,000 gain in non-farm payrolls in May, together with significant downward revisions to prior months' numbers.
But the biggest shadow hanging over the economy is coming from the uncertainty created by President Trump's multi-front trade war. As talks have collapsed between the U. S. and China, and rhetoric on both sides has begun to resemble Cold War dimensions, economists have had to factor in the possibility of higher consumer prices, disrupted supply chains, and falling exports. What's worse is that the situation with China looks like it will get worse before it gets better. And just this week, things got even dicier when Trump shocked everyone with his surprise tariff announcements against Mexico. Even though the administration had already invested much political capital in negotiating and pushing the United States Mexico Canada Trade Agreement (USMCA - the replacement for NAFTA), the president seemed more than willing to risk blowing up the entire agreement in pursuit of a win on border security. Such whimsical displays on trade policy may undermine the Administration's negotiations with all of our trading partners.
As I have argued in the past, most Americans are completely
unaware of the benefits we receive from free trade in the form of lower consumer prices and lower interest rates. When prices rise for everything sold in Walmart and when Americans face higher mortgage and credit card rates, the true cost of an ill-advised trade war will come into sharper focus.
With these uncertainties piling up, Powell stepped up to the microphone this week and told us what we already should have known: There is no more tightening bias and that the next move the Fed makes may be to cut rates not to raise them.
When the Fed last raised rates, controversially, back in December, I argued that that would be the last time it would do so, and that its next move would be a cut. At the time, those predictions were woefully out of step, bordering on delusional. To believe that the Fed would so quickly retreat after blowing the bugle of advance so loudly, would be to admit that it had no idea what it was doing, and that the best minds on Wall Street could not see a crisis looming in plain sight. Yeah. That's about right. Since they were all blindsided by the 2008 crisis, why should we expect their vision to be any clearer now?
The elephant in the room that no one wants to acknowledge is that the "unconventional" policies that were introduced to fight a "once in a century" crisis are now the conventional policies of choice to combat the normal fluctuations of the business cycle. But zero percent interest rates and quantitative easing only worked a decade ago because people thought they were temporary. If they knew that the policies were permanent, the dollar may have plummeted and the resulting inflation may well have overwhelmed any benefits the stimulation delivered. But the na?ve belief that the Fed could reverse course, unwind its bloated balance sheet and normalize interest rates, kept the game going and kept the dollar strong. Now that the illusion may about to be shattered, the dollar may not survive the next round of enhanced QE and ZIRP.
When the Fed first went down this road, I said it was a mistake. I likened the Fed's proposed exit strategy to pulling a table out from under a cloth while leaving the cloth and dishes suspended in mid-air. I said the Fed had checked us into a monetary roach motel, and that eventually there would be more QE programs than Rocky movies. While my analogies often drew laughs from my devotees, (
see my standup comedy routine), they were ignored by just about everyone else.
QE4 will have to be larger than the three earlier rounds combined, as the annual Federal budget deficits could exceed 3 trillion. However, while China, Russia, and many emerging market nations were eager buyers of Treasuries during those initial rounds, they may likely be sellers of Treasuries during the next round. That means none of the inflation created to finance QE would be exported. So the big price increases next time may take place in the supermarket rather than the stock market. Americans would finally be forced to deal with the adverse effects of inflation that we have been spared for the past 10 years. It's not going to be pretty.
Unfortunately, the economic carnage will be blamed on Trump and capitalism. So just like the 2008 financial crisis gave us Barack Obama, the coming crisis will give us something much worse; a Democratic president hell-bent on transforming America in the way Hugo Chavez transformed Venezuela. Socialism will not fare any better here than it did there.
In 2008 the Fed made a deal with the devil, sacrificing America's soul in exchange for a decade of phony growth. That decade is coming to an end, and the devil is here to collect his due.
Best Selling author Peter Schiff is the Chief Global Strategist of Euro Pacific Capital, a division of A.G.P. / Alliance Global Partners, a Registered Investment Advisor and a full-service broker/dealer.. His podcasts are available on The Peter Schiff Channel on
Youtube.