Is Another Financial Crisis Coming to the United States?
Updated
"In general, we find that monetary policy should react to asset prices and should try to “prick” or “burst” asset bubbles." (Roubini 2005) Though it is clear they have not done so, anyone can see that there is an asset bubble in the stock, bond, and housing markets yet the FED continues their Zero Interest Rate Policy, and continues to print money at unprecedented rates while increasing debt and the deficit. The government's refusal to curb asset prices many years ago has led to a massive asset bubble that is waiting to collapse as soon as they raise interest rates, but now because commodity prices are very depressed as compared to 2007 "then the level of corporate debt remains beyond that which can be financed out of the depressed cash flows of a recession, and debt continues to accumulate, setting off a chain reaction of bankruptcies." (Barnett 2000) This asset bubble has been exasperated by "investment managers [that] are willing to bear the low probability “tail” risk that asset prices will revert to fundamentals abruptly, and the knowledge that many of their peers are herding on this risk" which is particularly problematic in "an environment of low interest rates following a period of high interest rates" and can lead to "sharp and messy realignments" (Rajan 2005)
A "sharp and messy realignment" will lead to massive deflation in asset prices and force the government to increase their deficit spending to maintain their 2% inflation target, and because the primary way to finance a larger deficit in a depressed economy will be to print more money, and because "large budget deficits financed by money creation are widely believed to be the primary force sustaining prolonged high inflation processes." (Kiguel 1989) then this could lead to hyperinflation as deficit spending reaches unsustainable levels and the only way to conceivably pay it back is through hyperinflation or default.
If the FED would have raised interest rates many years ago when an asset bubble was becoming apparent then we could have possibly avoided such a big mess, but since they let this bubble extend out as far as possible without any attempt at curbing it when it does correct the FED is now left with very few tools to stimulate the economy. Interest rates are out. This leaves them primarily with printing money and deficit spending to raise inflation rates. They also have a few other tools, like raising the price of commodities artificially (see Gold Reserve Act). All of these methods will lead to the eventual destruction of the dollar and of any debts that are denominated in dollars, if and when another recession comes the government is left with the only option of destroying the dollar to save the economy. Now a destruction of the dollar is obviously a far off tale right now, but if this next recession comes then it is very likely to be the government's last resort to stimulate the economy and prevent a total financial collapse. Chances are it won't work to prevent a total collapse and the US will lose its position as the reserve currency of the world and we will fall into an extended period of economic turmoil. This will continue until there are "Substantial reductions in the budge deficit, monetary reform, and a fixed exchange rate." (Kiguel 1989) with outright elimination of the deficit being the most important factor.
A "sharp and messy realignment" will lead to massive deflation in asset prices and force the government to increase their deficit spending to maintain their 2% inflation target, and because the primary way to finance a larger deficit in a depressed economy will be to print more money, and because "large budget deficits financed by money creation are widely believed to be the primary force sustaining prolonged high inflation processes." (Kiguel 1989) then this could lead to hyperinflation as deficit spending reaches unsustainable levels and the only way to conceivably pay it back is through hyperinflation or default.
If the FED would have raised interest rates many years ago when an asset bubble was becoming apparent then we could have possibly avoided such a big mess, but since they let this bubble extend out as far as possible without any attempt at curbing it when it does correct the FED is now left with very few tools to stimulate the economy. Interest rates are out. This leaves them primarily with printing money and deficit spending to raise inflation rates. They also have a few other tools, like raising the price of commodities artificially (see Gold Reserve Act). All of these methods will lead to the eventual destruction of the dollar and of any debts that are denominated in dollars, if and when another recession comes the government is left with the only option of destroying the dollar to save the economy. Now a destruction of the dollar is obviously a far off tale right now, but if this next recession comes then it is very likely to be the government's last resort to stimulate the economy and prevent a total financial collapse. Chances are it won't work to prevent a total collapse and the US will lose its position as the reserve currency of the world and we will fall into an extended period of economic turmoil. This will continue until there are "Substantial reductions in the budge deficit, monetary reform, and a fixed exchange rate." (Kiguel 1989) with outright elimination of the deficit being the most important factor.
Note
Recessions can be managed if inflation expectations can be sustained, the problem is that it gets increasingly expensive for governments to maintain an arbitrary 2% inflation level for many years, especially when there are massive deflationary forces in play such as repeated recessions. "The evidence indicates that a substantial increase in [unemployment] can lead to deflation, but the depth and duration of the deflation depends on how well anchored inflation expectations are." (Williams 2009) So if inflation expectations become unachored from the FED target of 2%, as they have in the past, then the FED is forced to take drastic measures to maintain that 2% inflation rate as they did most recently in 2002 and 2008. These drastic measures require massive deficit spending which as they get larger, and as the economy falls into more recessions, can only be financed by money creation. I believe that if another recession happens it will push the deficit past the point of no return and it will eventually require the government to cause hyperinflation as a way to bring the debt under control. This will continue until there are "Substantial reductions in the budge deficit, monetary reform, and a fixed exchange rate." (Kiguel 1989) with outright elimination of the deficit being the most important factor.The FED will eventually have to raise interest rates soon or they will have to face a recession with no teeth, when rates finally start going up it will trigger a much bigger problem that cannot be avoided. I believe that this election and the lame duck session may have serious effects on the market, especially if the FED sticks with their plan of raising interest rates in December.
Note
Based on Neely's 1988 analysis of the DOW, and using his wave (2) as a starting point, it appears that we are in the middle of a large impulse cycle, though, it also appears that we could still be in a corrective subdivision of that impulse. If this were to correct severely from here we are probably still in part of Wave 4, and this could even be an x-wave like the roaring twenties. What followed that x-wave was the great depression and a long period of almost no growth. Fundamentals support another depression if the economy were to fall into a recession while commodity inflation remains low. A recession is likely to begin whenever the FED decides to raise interest rates and possibly after the election, both of which could eventually trigger a much larger depression and possibly a currency crisis if current monetary policy continues.
If a depression happens, then after about 10-20 years of practically no growth in the stock market we may finally see a break out in the up direction that will have very strong momentum and will likely be an extended wave 5 if my count is correct. This wave will end around Neely's time target of 2060 and approach or hit his price target of 100,000. This will complete Neely's third wave and likely usher in a new depression.
This count is still very speculative but fundamentals support it and on a lower time-frame there are more indications that this is very close to the top and is prefectly timed with the election and the FED planning on raising interest rates in December. I can already smell the steak cooking.
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